For many years, the price of gold moved up only when the stock market moved down. With limited supply and strong demand, the precious metal was the logical place to be when the global investment landscape was looking a little ragged.
No longer. Gold – unlike everything else – has rallied in each of the past 10 years. It's gone up when the U.S. dollar was soft and when the greenback was strong, when inflationary worries were paramount and when deflationary anxieties were in the headlines, when the economy was in recession and when it was expanding.
The past decade of consistent gains doesn't mean investors should be running out and stashing all their wealth in gold coins. It does suggest, though, that there are some great opportunities to be had in gold mining stocks.
Here's why. For much of the past few years, investors have sought safe-harbour refuge in gold, fearing their portfolios would lose value as central banks turned on the taps with loose monetary policies.
Gold has begun behaving less as a commodity and more like a currency. Its attractions are obvious: No central bank can print gold, and it is no country's liability.
In contrast, holding paper money is looking less and less attractive. Interest rates remain at rock bottom levels – in fact, the U.S. Federal Reserve in its most recent statement said short rates are now likely to stay negative for at least another three years, once you account for the bite of inflation. The Fed not only stated its intent to keep policy rates near zero, but the language in its most recent text suggested that a third round of quantitative easing – more money printing – is on the table.
And Fed chairman Ben Bernanke appears to have done a bit of a switch, indicating he will tolerate core inflation above a newly minted official objective of 2 per cent. The European Central Bank is also gearing up for more direct lending to euro area banks in February as it extends its own back-door version of quantitative easing.
So, if we accept the premise that gold is acting like a currency in a world where central banks in many countries are bent on depreciating their own paper money, one could conclude that bullion will rally against all these units.
Gold miners offer an attractive way to play this bullion rally. Mining is a tough business, but those companies that are successful at growing production and reserves, while holding the line on costs, offer significantly greater leverage than bullion to a rally in the gold price. Because input costs tend to be heavily concentrated in the early years of a rally, history has shown that gold miners' shares tend to dramatically outperform bullion in the later stages of a gold bull market.
The transition the gold-mining sector has undergone in recent years is amazing. After decades of deals that were often driven more by ego than financial acumen, CEOs now speak about financial discipline and return on capital. Many of the companies have begun paying dividends.
These stocks are trading at the bottom of their historical range – meaning they're ripe not only for gains but also for some good old-fashioned merger action, at least among junior firms.
The bigger question, of course, is whether gold's shiny complexion is permanent or a shorter-term phenomenon related to the unprecedented financial market developments of the past three years.
From my macro lens, the odds are high that the secular bull market in bullion remains intact. But the prudent investment approach to take is to buy a diversified basket of gold equities, with an emphasis on those with higher-grade projects in politically safe jurisdictions.
David Rosenberg