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 cements a new gold bullion ETF accumulation cycle which we expect to be a materially positive, long duration driver of the gold price.
• Despite being up 25% year-to-date and setting new all-time highs in nominal terms, the gold price remains well below its all-time highs adjusting for structural inflation factors, of approximately US$3,500 per ounce.
• Gold mining stocks are at what we believe is a roughly 25-year low in terms of valuation.
• 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.

Summary

Gold bullion (+5.2%) strengthened during September, driven by continuing momentum in its two key macroeconomic drivers (the yield on long-dated US Treasury notes in real terms and the US dollar). The US dollar weakened (the trade weighted US dollar index -0.9%) and Treasury yields in real terms (the nominal yield minus expected inflation) moved lower (the nominal yield on 10-year US Treasury notes fell by 12 basis points, driving the implied real yield 13 basis points lower).

The key driver of these macroeconomic factors was likely to have been the US Federal Reserve cutting interest rates for the first time since the depths of the COVID-19 pandemic in March of 2020. The moved marked the end of the interest rate cycle which was the steepest, longest interest rate cycle since the 1970s.

At the end of September, markets were pricing in an additional 75 basis points of cuts of by the end of 2024, and a total of 125 basis points of cuts during 2025, bringing the effective federal funds rate to approximately 3%.

Following the end of the US interest rate cycle, financial market participants in the gold market have continued their shift to accumulate bullion. So far during September, exchange traded funds (ETFs) are on track to have added to their gold holdings for the fifth consecutive month, which excluding the blip in gold demand from ETFs following Russia invading Ukraine in 2022, last occurred during the most recent accumulation cycle which concluded in November 2020.

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. ETFs typically account for 5-10% of demand or supply within these cycles (although 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.

The price of gold bullion finished September at US$2,635 per ounce (+5.2%) and silver at US$31 per ounce (+8.0%). Both metals appear to 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$2,672 per ounce on 26 September) 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 approximately 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 (+2.9%) 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 economic uncertainty) underperformed global equities during September, which was likely related to lingering fears in relation to the risk of a US recession.

Over a longer time horizon (as of 30 September, since a peak in gold price in August of 2020 prior to the interest rate hiking cycle, the gold bullion price has risen 25% and gold mining equities have declined by 10%), 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 during this time). This phenomenon has resulted in valuations on gold mining stocks in terms of their discount to gold bullion contracting to what we believe is a roughly 25-year low (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 and intra-sector 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).