CUR - Buy Gold Not The Gold Mining Stocks If You're Expecting A Recession

2023-11-01 15:29:54 ET

Summary

• The U.S. economy grew by 4.9% in Q3, one of the most robust quarterly growth rates in the past decade.
• Gold prices have surged, reaching over $2,000 per ounce, with a 10% gain so far in 2023.
• Investors and traders have options for accessing the gold market, including physical gold, gold futures, and gold-focused equities.

By Andrew Prochnow

As we predicted, the U.S. economy grew during Q3. Last quarter, U.S. gross domestic product ((GDP)) grew by 4.9%.

Excluding the post-pandemic recovery, this stands out as one of the most robust quarterly growth rates in the United States over the past decade. However, it might be a bit early to celebrate.

Looking ahead, the economy is projected to expand at a considerably slower pace, and there's even the potential for it to slip into negative territory in the first half of 2024. Given this outlook, many investors and traders are likely contemplating where to allocate their capital. For some, the answer may lie in gold or gold-focused investments.

Gold prices have shown recent momentum, with the world's most renowned precious metal surging to over $2,000 per ounce—coming within $75 per ounce of its all-time peak. Gold has registered a roughly 10% gain so far in 2023.

Given the ongoing global events, including two major world conflicts and the looming prospect of an economic slowdown, it's challenging to pinpoint the precise reason behind the recent upswing in gold prices. It could be attributed to a "flight to safety," a strategic shift, or merely the current market trend.

Nevertheless, there are certainly market participants seeking to capitalize on the recent momentum in this sector of the financial markets. Investors and traders have three primary routes for accessing the gold markets.

The first involves physical gold (XAUUSD:CUR), encompassing items like gold coins, bars, and jewelry. The second avenue pertains to gold futures, which essentially signify a commitment to purchase gold at a later date. Alternatively, investors and traders can opt for gold-focused equities, such as gold-focused ETFs like the renowned SPDR Gold Trust ( GLD ), or shares in gold mining companies .

The choice of how to invest in gold will vary depending on one's perspective, investment strategy, and risk tolerance.

For example, if one were to buy gold as a safe haven —to protect against a breakdown in the financial system—then physical gold (coins, bars, jewelry) might make sense. That's because a system-wide financial crisis could negatively impact the stock market (i.e. gold stocks) and/or the futures markets (i.e. gold futures).

A Brief History of Gold's Interaction with the U.S. Dollar

One significant aspect to keep in mind in this domain is the historical inverse relationship between gold prices and the U.S. dollar.

In this context, gold prices often tend to rise when the U.S. dollar weakens, as investors and traders in the currency markets typically turn to gold (among other assets) during such periods. Conversely, when the U.S. dollar strengthens, the reverse tends to occur.

Another key factor to note is that gold is denominated in U.S. dollars. This means that as the U.S. dollar loses value, more dollars are needed to purchase the same quantity of gold. Conversely, as the U.S. dollar gains in value, fewer dollars are required to acquire the same quantity of gold.

For the aforementioned reasons, investors and traders deploying short-term capital in the gold market may first want to consider their outlook on the U.S. dollar . If one expects the dollar to depreciate in the foreseeable future, then an attractive opportunity may exist to buy gold.

On the other hand, if an investor or trader were expecting the dollar to strengthen during the foreseeable future, then a long gold trade may not be optimal. For investors with a longer-term perspective, however, the dollar dynamic may be moot—especially for “gold bugs” that firmly believe in the metal’s future potential.

Investing in Gold During the Prospect of an Economic Downturn

At this time, one of the big considerations in the gold market is the potential for a recession.

Historically, the stock market has underperformed during previous recessions. Moreover, these periods have also encompassed sharp corrections in the stock market, which can trigger so-called “flights to safety.”

Gold is traditionally one of the beneficiaries of such flights to safety, as are government bonds.

As noted earlier, physical gold represents a potential option for investors and traders seeking to safeguard their capital against disruptions in the financial system. However, it's essential to consider the security aspect of this choice, as physical gold must be stored securely.

The additional expenses and risks associated with storing physical gold may not be the preferred choice for some market participants.

Futures markets represent another avenue for investing in gold. A futures contract essentially represents a promise to purchase a specific amount of gold for a specific price at a predetermined date in the future.

If an investor or trader holds a futures contract through expiration, then he must take delivery of the physical gold. However, the vast majority of futures contracts are closed prior to expiration, or rolled-over.

The one challenge for gold futures is that notional values in traditional futures markets are high, which means significant capital is required to efficiently trade the commodities futures markets. That said, new products have entered the marketplace which offer small investors and traders a more capital-efficient method to access commodities futures.

Due to the capital constraints and complexity of the futures markets, some investors and traders instead choose to access gold exposure through the equity markets. Assuming this approach fits one’s outlook, trading approach and risk profile, this can also be effective.

However, before entering a gold-focused position in the equities market, investors and traders should be aware of the nuances of trading these securities. Gold-focused equities include the companies that mine for gold, as well as gold-focused ETFs.

Some of the best-known gold mining stocks are highlighted below (sorted by year-to-date return):

• Harmony Gold ( HMY ), +33%
• Gold Fields ( GFI ), +25%
• Kinross Gold ( KGC ), +24%
• Alamos Gold ( AGI ), +24%
• Franco-Nevada Corp ( FNV ), 0%
• Barrick Gold ( GOLD ), -8%
• Agnico Eagle Mines ( AEM ), -9%
• Royal Gold ( RGLD ), -9%
• Freeport-McMoRan ( FCX ), -11%
• Newmont Corp ( NEM ), -20%

The gold miners are somewhat unique because they can sometimes exhibit split personalities.

That’s because companies that mine gold are partly exposed to the underlying price of gold, and partly exposed to the general direction of the stock market. The former because they mine and sell gold—thus relying on prevailing prices—and the latter because they are publicly traded stocks.

Looking at an example, one can see that shares of Newmont Corp ( NEM )— the largest capitalized gold mining company in the U.S. —have exhibited significant volatility during previous economic recessions. Amidst the 2008-2009 Great Recession, shares in Newmont corrected by about 50% (January 2008 to November 2008).

Along those same lines, shares of Barrick Gold ( GOLD ) also declined by more than 50% during that same period.

In contrast, gold prices only corrected by about 25% during this same period, while the overall stock market corrected by more than 50%. These figures help illustrate how gold mining stocks traded more in line with the stock market during that financial crisis, as opposed to trading like proxies for gold.

Importantly, ETFs like the GLD traded more closely in line with the gold market during the Great Recession. From peak to trough in 2008, GLD sank by about 25%, which was right in line with the pullback in the broader gold market.

These examples help illustrate how gold ETFs like GLD and the iShares Gold Trust ( IAU ) represent a different investment proposition than the gold miners. Both of these ETFs are up roughly 9% so far in 2023, which is closely in line with the 10% positive return in gold prices.

A brief examination of historical correlation data also supports this course of action. According to research conducted by tastylive, the average 3-month correlation between GLD and /GC (e.g. gold futures) is about 0.87, which is extremely high. For comparison the historical correlation between gold and silver—which tend to trade in lockstep—is roughly 0.89.

Taking all of the above into account, investors and traders expecting a recession may want to bypass the gold mining stocks, and instead focus on physical gold, gold futures or gold-focused ETFs such as GLD, IAU or the SPDR Gold MiniShares Trust ( GLDM ).

Andrew Prochnow has more than 15 years of experience trading the global financial markets, including 10 years as a professional options trader. Andrew is a frequent contributor Luckbox Magazine.

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