We share our latest observations on global asset markets in relation to T8 Gold

All movements are expressed in United States (US) dollar terms, unless otherwise stated.

Key points

• We believe the US interest rate cut during September cements a new gold bullion ETF accumulation cycle which we expect to be a materially positive driver of the gold price over a 3-4 year period.
• Despite being up 33% year-to-date, setting new all-time highs in nominal terms and appearing over-bought from a technical perspective, the gold price remains well below our estimate of the all-time high of US$3,500 per ounce (adjusting for structural inflation factors).
• We believe the higher and higher prices at which central banks have been purchasing gold (central banks have accounted for 20% of gold demand so far this year, more than double the post-financial crisis average of around 10%), especially over the last six months, has the potential to create a floor under the gold price, or a dynamic akin to a ‘central bank put’.
• Recently, gold mining stocks have not been exhibiting their typical commodity producer leverage to the gold price. We expect this to prove a temporary phenomenon, creating considerable asymmetry for gold mining stocks.
• Gold miner profit margins have expanded materially which is a factor contributing to gold mining stocks trading at what we believe is a roughly 25-year low in terms of valuation.

Market update

Macroeconomic data

During October, gold bullion (+4.2%) strengthened notwithstanding its two key macroeconomic drivers (the yield on long-dated US Treasury notes in real terms and the US dollar) acting as a headwind. We assume gold’s insensitivity to these factors in the short term has most likely been related to the present level of geopolitical uncertainty (e.g. the wars in Ukraine and the Middle East) and uncertainty related to the US election.

The US dollar strengthened (the trade weighted US dollar index +3.2%) and Treasury yields in real terms (the nominal yield minus expected inflation) moved sharply higher (the nominal yield on 10-year US Treasury notes rose by 50 basis points, driving the implied real yield 32 basis points higher).

The key driver of these macroeconomic factors was stronger than expected labour market data and hotter than expected inflation, shifting expectations for interest rates. Further, as the US election drew closer, a realisation seemed to dawn on the market that neither candidate was prioritising fiscal responsibility and the budget deficit is increasingly seen as unsustainably high. This may also have contributed to yields being driven higher. The election of Trump therefore doesn’t change this dynamic (Trump’s team has been discussing additional tax cuts) and it is an important issue to monitor.

In terms of the outlook for interest rates, at the end of October, markets were pricing in an additional 50 basis points of cuts of by the end of 2024 (relative to 75 basis points only one month earlier).

Gold bullion market

Following the end of the US interest rate cycle, financial market participants in the gold market have continued to accumulate bullion. Exchange traded funds (ETFs) have added to their gold holdings for the sixth consecutive month, which last occurred during the 2016-2020 accumulation cycle. This combined with central banks buying gold at double the average rate since the financial crisis is continuing to squeeze the gold price higher.

Gold ETFs

We should underline once more that Gold ETFs are the key swing factor in the gold market on the basis that they can contribute materially to both demand and supply, depending on whether they are in an accumulation or liquidation cycle.

While ETFs typically account for 5-10% of demand or supply within these cycles, history has often seen individual quarters where they have accounted for 20% and in extreme cases as much as 40% of demand or supply. These cycles are driven by gold’s two key macroeconomic drivers, described above.

We believe gold ETFs have entered a new accumulation cycle, and our base case assumption is that it will be an upward catalyst for the gold price over a multi-year timeframe. The last accumulation cycle ran for nearly five years up to the third quarter of 2020, averaging 10% of global demand for gold. The liquidation cycle that followed ended in May 2024 and, excluding the blip following the invasion of Ukraine by Russia, on average accounted for approximately 7% of global gold supply. Under a scenario of equivalent flows into ETFs (and all else being more or less equal), we would expect the gold bullion price to strengthen by 25% on a 12-month view.

Central banks

Central banks have accounted for 20% of gold demand so far this year, more than double the post-financial crisis average of around 10%. We believe the higher and higher prices at which central banks have been purchasing gold, especially over the last six months, has the potential to create a floor under the gold price, or a dynamic akin to a ‘central bank put’.

Outlook for the gold price

The price of gold bullion finished October at US$2,744 per ounce (+4.2%) and silver at US$33 per ounce (+4.8%). Both metals remain in an established uptrend.

Silver, often considered gold’s poorest cousin, is attracting considerable attention driven by a combination of industrial demand from the solar industry (the photovoltaic solar industry accounts for 15-20% of total demand, growing at approximately 20% per annum) and as a precious metal similar to gold bullion (silver and gold have had a nearly 0.9 correlation over the last 10 years) for investment purposes. In June we published a report on the opportunity that we see in silver.

While the current gold price is setting new all-time highs in nominal terms (US$2,788 per ounce on 30 October) and is trading above historic all-time highs in real terms using official inflation (US$2,533 per ounce in January 1980), we reflect that it is trading nowhere near its all-time high when adjusting for structural inflation to the cost of producing gold over this time.

Structural cost inflation in gold production is related to factors including the average grades of ore mined falling and the average depth of mines increasing over time. In addition, the mining industry has seen material cost inflation associated with meeting contemporary safety and environmental standards. None of these factors are captured in official inflation measures. The cost of energy has also increased which is only partially captured by measures of official inflation. As a result, today the marginal cost of gold production (the ninth decile of the cost curve) is well over US$2,000 per ounce (in All-in Sustaining Cost, or AISC terms), which has increased at greater than 5% per annum since 1980 (or two percentage points above official inflation).

Adjusting for these factors, we estimate the all-time high gold price in 2023 dollars (real terms) would be approximately US$3,500 per ounce. Silver has even more potential, trading nowhere near its all-time highs in nominal terms (nearly US$50 per ounce in 1980 and 2011) or real terms (nearly $150 per ounce in January 1980), let alone adjusting for true inflation to its production cost.

Gold mining equities

Gold mining equities (+1.4%) strengthened, albeit clearly lacking their typical beta of 2 to the gold bullion price (whereby if the gold price moves by one unit, the gold mining equity price would be expected to move by two units on the basis that the operating margin expands by more than the movement in the commodity price).

In the short term, this phenomenon was likely related to the sector’s market cap factor which makes it a subset of small cap equities (on the basis that the average market capitalisation of the Gold Miners Index is approximately US$7 billion and the median is less than US$2 billion). Small caps (which are highly sensitive to interest rates and economic uncertainty) underperformed global equities during October, which was likely related to the sudden shift in interest rate expectations.

Over a longer time horizon (as of 31 October, since a peak in gold price in August of 2020 prior to the interest rate hiking cycle, the gold bullion price has risen 33% and gold mining equities have declined by 9%), we believe the explanation is that central banks don’t buy gold mining equities (central banks buying gold bullion was the key driver of the gold price over this period). This phenomenon has resulted in valuations on gold mining stocks contracting to what we believe is a roughly 25-year low (in terms of their discount to gold bullion, based on the spread between the spot gold price and the gold price implied by the market price of the equities). Further, we observe that gold equities have rarely been cheaper than the present time over the last 40 years.

We see this dislocation as a significant opportunity which investors haven’t yet woken up to. We believe a normalisation is inevitable driven by gold sector momentum becoming impossible for equity investors to ignore and mergers and acquisitions chasing gold mining equities’ strong fundamentals and the above-mentioned compelling valuations. History suggests that the normalisation of such a dislocation is likely to be rapid (as opposed to gradual).

Potential for M&A from outside of the gold sector

In terms of mergers and acquisitions, we speculate that unusually, appetite to acquire gold producers could come from outside of the precious metals sector. Traditionally gold miners have traded at a premium to other mining companies on the basis that established, well managed, long-life gold producers generally have a beta of less than one (on the basis of gold’s safe haven characteristics), relative to the equivalent miner producing industrial metals (e.g. copper) having a beta of greater than one. This attribute creates what is known as the ‘gold premium’ and over the long-term has resulted in those established gold miners trading on one-year forward price-to-free cashflow multiples of around 20 times and copper miners trading on around 10 times.

This meant that gold miners were discouraged from acquiring copper miners because of the risk to the gold premium of their existing assets and copper miners were discouraged from acquiring gold miners because of the relative valuation and risk to the gold premium of the assets they were acquiring.

At the present time using spot commodity prices, the long-term valuation dynamics described above have inverted. For example the world’s largest publicly traded gold miner, Newmont is making 54% EBITDA margins and trading on 9 times (less than half its typical long-term mid-cycle multiple) and the world’s largest listed copper miner, Freeport McMoRan is making 40% EBITDA margins and trading on 22 times (more than double its typical long-term mid-cycle multiple).

Clearly part of the reason is that markets assume the copper price will be higher and the gold price will be lower in future, however this doesn’t account for the magnitude of the difference (especially considering the relative beta, which is akin to one of the laws of physics).

So what? For the first time, we believe that it would be possible (and rational) for industrial metals miners to acquire major gold miners. After all, only approximately 80% of what Newmont produces is gold (with the remainder being industrial metals) and approximately 80% of what Freeport McMoRan produces is industrial metals (with the remainder being gold). Further, exploring for, developing and operating most gold mines is not materially different to most copper mines.