Bloomberg reports that the precious metal is off to its best start to a year since 1974. That has caught the attention of investors. Holdings in ETFs backed by the yellow metal are up 18% so far in 2016. Inflows into those ETFs have been at the fastest pace since 2009.
After being scorned for so long, why has gold suddenly become precious again?
There are a number at factors at play here. First and foremost: central banks.
Central Banks and Gold’s Rise
Perception is reality. And there is growing perception that central bankers are losing control. The number of tools in the toolbox used to stimulate economic activity seems to be running low.
Recent central bank policy actions in both Japan and Europe seem – at least to some market participants – to have an air of desperation. I particularly refer to central bankers moving policy deeper and deeper into the uncharted territory that is negative interest rates.
JPMorgan Chase (NYSE: JPM) pointed out an interesting historical fact. In looking at data going back to 1975, monthly returns for gold averaged 1.4% in periods of low and falling U.S. interest rates. That compares to the long-term average of 0.4%. In other words, falling rates are good for gold.
That is especially true in this world of negative interest rates. One longstanding argument against holding gold is that it pays no interest or dividend. That’s still true today. But when compared to the more than $7 trillion worth of sovereign bonds around the world with negative yields, gold’s zero yield looks good in comparison.
In Japan, for instance, the move into negative rates has spurred two activities. First, the buying of safes. The Japanese don’t seem to like the idea of paying banks to hold their money. And according to Japan’s largest bullion retailer, it also rekindled interest in buying gold.
Good as Gold
In addition to the central banks, the basic supply-demand fundamentals are positive for gold.
The capital expenditure slashing cycle is just getting started in oil and industrial metals. But it has been underway for years in the gold industry. That means gold production has likely peaked for this cycle.
2015 recorded the slowest annual growth in gold output since 2008, and the first quarterly actual decline in production. Thomson Reuters GFMS forecasts that gold output from mines will actually decline by 3% in 2016.
And this trend should continue for at least several years. Speaking to the Financial Times, the CEO of Russian gold miner Polymetal (OTC: AUCOY), Vitaly Nesis, said, “I think supply will drop by 15 to 20 percent over the next three to four years.”
The president of Barrick Gold (NYSE: ABX), Kelvin Dushinsky, apparently agrees. He told the Financial Times, “Falling grades and production levels, a lack of new discoveries, and extended project development timelines are bullish for the medium and long-term gold price outlook.” Barrick is the world’s largest miner of the yellow metal.
The final factor is more psychological. Gold investors remember back to the turn of the century. When the Bank of England sold more than half of its gold reserves between 1999 and 2002, it marked the start of gold’s bull run. Since 2000, gold is up 335%. That outpaces the S&P 500’s return of 35%.
Today, we have a similar move from the Bank of Canada. It unloaded all of its gold holdings. Traders are already calling it the “Poloz’s Bottom,” in honor of the Bank of Canada’s Governor Stephen Poloz.
With all these factors lining up positively for gold, how should investors play it?
If you want to actually own gold over the long term, I would opt for owning the actual bullion or gold coins.
I do not advise buying ETFs unless you are just looking for a quick trade. With all the lending surrounding gold by the major financial institutions, my belief is that the ounces of gold held by these ETFs will have multiple claimants.
One exception though is the Van Eck Merk Gold Trust (NYSEArca: OUNZ). By simply filling out a form with your broker, you can convert holdings in OUNZ into gold bullion or coins.
My second choice is one I’ve talked about before: the world’s biggest and most successful gold royalty and streaming company, Franco-Nevada Corp. (NYSE: FNV). I consider it to be the premier royalty and streaming company in the world.
Franco-Nevada is safer than buying gold mining companies. That’s because all it does is provide funding for projects it has done its due diligence on to miners in exchange for royalties on future gold production.
Despite its conservative business model, Franco-Nevada’s stock outperformed both gold and the S&P/TSX Global Gold Index since 2008. And it raised its dividend from $0.04 a share in 2011 to $0.21 a share in 2015. That’s a 424% increase while gold declined 38%.
If an investor wants to actually own a gold mining company, my third choice is Randgold Resources (NASDAQ: GOLD). This African-focused gold miner is very different than most in the industry. It actually raised its dividend by 10% this year.
How? Believe it or not, Randgold has a debt-free balance sheet.
Besides the dividend raise, having no debt allowed Randgold to keep exploring while the other miners pulled back. It also gives the company lots of financial firepower to possibly pick up quality assets on the cheap from distressed gold miners.
All three selections should do very well if indeed the “Poloz’s Bottom” is in.
This article is brought to you courtesy of Tony Daltorio from Wyatt Investment Research.