The Bull Market That Maybe Should Be Noticed
By Neland Nobel
Estimated Reading Time: 6 minutes
Financial aficionados and most of the financial press are focused on what stock, bonds, and real estate are doing. That should not be surprising since that is where Americans have the bulk of the money.
We agree as we have written a number of recent pieces about the market, its valuation extremes, and DeepSeek’s tech challenge. We have also run multiple articles on real estate and housing prices, which is essential to most of us.
However, to our credit, we have also followed gold for our readers. In addition, we have explicitly recommended it on multiple occasions.
Usually, significant moves in an investment involve heavy public participation. We certainly see that now in the stock market. For now, at least, gold seems to be the exception to the rule. Flows into gold bullion ETFs have been negative for the most part. Hedge fund and futures speculation are subdued. Bullion dealers that we interviewed tell us the public has been an overwhelming seller. The higher the gold price has gone, the more the public is selling. There is little indication of either public buying or much public interest, which has been confirmed for some time.
Yet, gold has quietly gone to another new high above $2,800 per ounce.
This is odd, to say the least. Maybe it is because older investors bought gold years ago and now need the cash. Or are they selling gold to buy Bitcoin or Nvidea? Whatever happens, it is essential to note that the gold price has reached this level with minimal public support. That suggests the market will have legs to go much higher because the investing public will eventually notice and want to participate.
The public in Western countries seems absent from the gold market. Buyers have been chiefly in Asia and notably among central banks. This is also quite positive. The buyers appear long-term in their orientation. Central banks don’t buy to “day trade”; they buy to hold. Thus, this gold will be “sticky” and not likely to come back on the market even if prices increase.
As we wind up the month of January, there will be much comment about the “January effect.” Wall Street wisdom says, as goes January, so goes the year. Now that we have concluded the key month of January, what do returns look like?
As we conclude January, stocks are up about 2.68%, which is supposed to bode well for the new year. Gold bullion is up almost 7.35%, Silver is up 10.34%, and GDX, the ETF holding gold mining shares, is up nearly 15% for the month. The trailing 12-month return for gold is just shy of 40%.
Gold has just broken out to a new high, and it would seem hardly anyone has noticed. Well, we have, and we think it is significant.
The backdrop for gold would, at first, appear negative. Republicans are expected to reduce spending and narrow the deficit. The dollar has been robust. We are told inflationary pressure is ebbing. There has been a ceasefire in the Israel/Gaza war, and the Trump Administration will be pushing for a negotiated end to the Ukraine War. The Federal Reserve has declined to continue cutting interest rates, suggesting they know the inflation dragon has not been slayed and their “pivot” was premature. But it is unlikely they will raise rates. It seems odd to see gold take off to the upside if all this is true.
Whatever the causes, the proof is in the price action, which is undeniably positive. There must be more demand than supply.
Because of the intractable nature of solving the US budget crisis and the fact that all governments today resort to the printing press to pay their bills, we have long advocated investors hold some portion of their investments in gold bullion coins. Last year, such holdings provided higher returns than the stock market, and they have continued that action thus far in January.
While gold mining shares are paper investments in a corporation, they can provide speculative opportunities to those who think gold prices are headed higher. Once a decent hedge position has been taken in gold coins, we believe they are worth a look because they are outstandingly cheap and ignored by the public.
The chart below is a relative strength chart of gold bullion and the HUI or gold bugs index to provide a sense of relative valuation. HUI is an index representing the performance of gold mining shares that don’t hedge their production. It is essential to mention that this is not a price or performance chart. It is a chart of the relative value and price action between bullion and mining shares.
When gold bullion performs better than the shares, the numerator increases faster than the denominator. Thus, the ratio goes upward. When the shares do better, the ratio falls. Basically, the mining shares have underperformed bullion for about 20 years. Mining companies have been plagued by difficulty finding new reserves, overspending, poor management, destruction of investor confidence through stock dilution, and geo-political problems. Many gold mines are located in third-world countries in Africa and South America that don’t have the rule of law and where state expropriation of mining properties is always a threat.
There is a risk that this inferior performance will continue, but we don’t think it will.
Besides the relative strength trend between the two, the chart also shows the valuation relationship between the two. Right now, an ounce of bullion can buy over 10 units of HUI, while back in 2004, the shares were so expensive one ounce of gold could only buy 1.6 units of HUI. At above 10, the mining shares are currently very inexpensive relative to gold.
Given all the problems the shares have had, why should we even look at them? There are several reasons. Many companies have been severely punished, and some now have good management. While many do have properties in rough areas of the world, that is already in the price, and besides, one can select shares that don’t have high geopolitical risk. Here is a case where good stock picking is better than indexing.
Gold mining, as an industry, is small relative to many other sectors and thus can be moved by only a modest change in investor money flows. Finding the exact capitalization number is problematic because, usually, the mining company mines another mineral besides gold. For example, the market cap of Newmont, Barrick, and Agnico-Eagle together comes to about $135 billion. Just one large oil company like Chevron weighs in at $266 billion.
GDX and other indices are capital-weighted, which means a few giant companies like Barrick and Newmont dominate the index. Well, they have a lot of mining operations in some dicey locations. However, you can find companies that primarily have operations in Canada, Australia, Finland, and the US that are more stable politically and legally.
Finally, the mining shares offer the potential of leveraging the price action of gold. To explain that, let’s do a little basic math to illustrate.
Let’s say a mining company has an all-in sustained cost (that includes all costs, including restoration of the land when the mine plays out) of $1,500 per ounce. If gold costs $2,000 per ounce, they can book $500 profit per ounce mined. If gold gets to $3,000 per ounce, and all other expenses stay about the same, the profit per ounce mined is now $1,500 per ounce, a tripling of profits. If profits triple, the price of the stock should also go up by similar amounts.
What if you bought an ounce of gold at $1,500 per ounce under the same scenario? At $3,000, you have doubled your price, but you have not tripled your price. Mining shares thus historically increase faster than the bullion price.
Also, capital gains taxes are higher on gold bullion (28% as a collectible) than 15% on securities. Some mining shares pay dividends, while bullion does not.
OK, let’s test the theory of leverage. During the last big gold bull market from 2002 to 2008, gold bullion rose from around $250 per ounce to about $1,800. That was a move of over 6 times. That is an outstanding gain considering that, as an inert metal, it has no enterprise risk like a company. It all occurred during the Great Financial Crisis.
Agnico Eagle, a well-run company with production mainly in Canada, moved from a low of about $3.75 per share in 2002 to a high of about $69 a share, or about 18 times. In short, it moved about three times more than bullion. That has been typical of past cycles.
Historically, gold mining companies move opposite the stock market. The best-performing stocks during the Great Depression of the 1930s were Homestake Mining and tobacco companies.
We are not suggesting we are going into a great depression, although you can’t rule it out. We are just saying that, at times, gold mining shares have been terrific at hedging risk and providing gains when conditions for the mainstream of stocks are not good.
Now, owning bullion is less risky. It can’t be seized by a corrupt African government or go out of business. A mining company could, so, know the difference. However, once you have taken a good safety position in bullion coins, adding some selected gold mining shares may make sense if you think gold is going higher. This is something to discuss with a financial advisor, hopefully, one that is not overtly hostile to owning some gold-related assets and is knowledgeable about the market sector.
If gold is going higher, gold bullion will be going higher, and so will quality gold mining shares. Both could help balance a portfolio in turbulent times ahead.
At some point, the public will notice what is going on. In a sense, a rising gold price will eventually attract investor interest.
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