Logical correlations feel good; divergences can make investors uncomfortable. Yet, as the gold price moves in one direction and gold-mining stocks go the other way, there may be a compelling opportunity for those who can withstand some short-term discomfort.
Loyal gold holders, sometimes known as “gold bugs,” might maintain that physical gold is the best investment. However, it’s not always convenient or even possible to put tangible gold in one’s portfolio.
That’s why mining stocks can provide a good proxy. They closely follow the spot gold price — or at least, they usually do — but that correlation has broken down lately. Understanding why this might be happening is a solid first step toward assessing the potential for high-conviction gold-producer stocks to play catch-up in 2024.
Gold finally breaks out
Before you can seriously think about buying gold-mining stocks, you’ll certainly want to have a firm belief in a rising gold price. After all, falling gold prices would undoubtedly make it difficult for producers to generate robust revenue.
From 2020 through 2023, gold just couldn’t get above $2,000 and stay there. It was a frustrating period that frayed the patience of even the most stalwart gold bugs.
Along the way, the annualized U.S. inflation-growth rate peaked at 9.1% in June 2022. One might assume that high inflation would spark a massive rally in the gold price — like it did in the 1970s.
However, it just didn’t happen this time. The attractive yields on government bonds were a primary contributing factor. After all, it’s awfully tempting to secure a 5% yield from Treasury bonds when it’s risk-free and easily fits into most portfolios, versus gold with its associated risks.
However, the rush to gold was delayed, rather than eliminated entirely. Gold recently broke decisively above $2,000 and even hit $2,350. What’s going on, exactly?
There are no earnings reports or conference calls with gold, so investors are left to figure out why the yellow metal is red-hot now. Perhaps it’s the prospect of bond yields falling as financial traders anticipate three interest-rate cuts this year.
Then there’s the almighty dollar, which showed surprising strength during the aforementioned period of 2020 through 2023. As State Street Global Advisors Chief Gold Strategist George Milling-Stanley explains, traders expect the dollar to back down amid a backdrop of declining interest rates:
“If interest rates are going to come down, and that’s what Jerome Powell keeps telling us, then the dollar is going to soften, and when the dollar softens, gold tends to do better.”
Indeed, gold is already doing “better” than it did for several stagnant years. As it breaks out, one might conclude that gold-related stocks should make a magnified move higher. Blue Line Futures President Bill Baruch succinctly clarifies the reason for this assumed correlation:
“Gold stocks are supposed to outperform the metal when gold’s price is rising. Their leverage to gold justifies outperformance. For any given move in the price of gold, operating cash flow generated by these companies increases (or decreases) by a much greater percentage.”
That makes sense — but then, price moves in the financial markets don’t always make sense, do they?
The divergence and the opportunity
It’s not difficult to find commentators pointing out the divergence between rising gold and not-rising mining stocks. This raises the prospect of gold-producer stocks playing catch-up to gold:
If anybody would know why gold stocks haven’t caught up to the metal yet, it would be Barrick Gold (NYSE:GOLD) Chief Financial Officer (CFO) Graham Shuttleworth. As he points out, the gold price may be rising, but the process of getting gold out of the ground isn’t cheap:
Things like cement, lime, explosives, steel — there’s still a little bit of inflationary pressure in those areas, which we’re working on to bring down.
Thus, there’s the problem. From equipment and labor to processing costs, practically every step of the gold-production supply chain has been touched by the brutal hand of inflation.
Shuttleworth might assure investors that Barrick is “working” to ease its inflationary issues, but it can’t control the prices of products like cement and steel. Consequently, eager investors shouldn’t expect gold stocks to zoom higher next week or even next month.
Alas, catching up will be a process, not an event. Still, if you expect the U.S. inflation rate to come down over the following months, then gold stocks like Barrick, Newmont (NYSE:NEM) and Kinross Gold (NYSE:KGC) might, at long last, have their moment to shine.
Disclaimer: All investments involve risk. In no way should this article be taken as investment advice or constitute responsibility for investment gains or losses. The information in this report should not be relied upon for investment decisions. All investors must conduct their own due diligence and consult their own investment advisors in making trading decisions.
