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For an allegedly precious metal, gold has gone without love for a long time. Trillions from global central banks have lifted many assets—from stocks and bonds to Manhattan condos—to or close to record highs, yet gold continues to slump near $1,250 a troy ounce, well off its 2011 peak near $1,900.
Just when you’re ready to relegate gold to the heap of has-beens along with frankincense and myrrh, it has quietly crept up 9% this year, with the latest spurt coming Friday after President Donald Trump launched airstrikes in Syria and after March job growth proved underwhelming. And there are good reasons to believe that gold’s outlook is finally brightening.
For a start, years of middling underperformance and competition from perkier stocks and bonds have taken their toll, and today gold is among the most spurned and underowned assets. A March survey of 200 global fund managers by Bank of America Merrill Lynch showed a net 8% who now say gold looks undervalued—after many years when the majority said gold was overvalued. Yet this 8% is still low enough to suggest that the case for gold isn’t yet widely embraced.
Overproduction has also corrected after prices peaked in 2011, even as demand continues to grow, especially in Asia. “Consumption by Turkey, India, China, and Russia alone have exceeded global mine supply since 2013, which means that inventories of physical metal held in Western vaults are being depleted to meet demand,” says John Hathaway, co-manager of the Tocqueville Gold fund (ticker: TGLDX).
Hathaway highlights two other overlooked catalysts: First, a new Shariah gold standard was approved late last year, which could spur the creation of gold exchange-traded funds for the Islamic world, home to about a quarter of the world’s population. On top of that, countries including China, Russia, Saudi Arabia, and Iran increasingly use gold as a settlement currency when trading oil and other commodities, and Beijing has made no secret of its plan to encourage wider international use of the yuan through gold convertibility, instead of relying on the U.S. dollar for trade.
We know, of course, that gold is a hard-to-value commodity with no real industrial function, and its ups and downs can seem less fathomable than a teenager’s mood swings. But it often takes a cue from real interest rates, which are essentially nominal interest rates minus inflation. It’s no coincidence that gold’s long bull market unfurled from 1999 to 2011 against a long decline in real rates, or that gold fell in 2011 as real rates started to tick higher.
It makes sense that gold thrives when real rates wilt: Robust yields on other assets make investors less keen on owning a precious metal with no industrial use. On the other hand, when real rates are low and investors are less confident in fiat currencies, the opportunity cost of holding gold declines, as well.
Michael Purves, Weeden’s chief global strategist, thinks real rates will stay contained or prove weaker than investors expect, which would be a boon for gold. Our nominal interest rate, as denoted by the yield on 10-year Treasuries, initially spiked on Trump’s promise of tax cuts and fiscal spending, but it has since stalled below 2.6% and is plumbing five-month lows. Foreign buyers frustrated by lower yields overseas—10-year government bonds yield just 0.22% in Germany and 0.05% in Japan—help keep a lid on U.S. yields. At the same time, U.S. inflation readings are creeping up.
Having surmounted recent resistance near $1,250, gold can quickly move up to its 2016 high near $1,375, says Purves. In the longer term, any whiff of stagflation—weak economic growth combined with inflation—could propel gold even higher. So could increased volatility from recent comatose levels.
BESIDES GOLD mutual funds like Tocqueville, gold bugs have their choice of ETFs, starting with the SPDR Gold Trust (GLD), which tracks the performance of gold bullion. Aggressive, longer-term investors with the stomach for volatility might look to gold miners, which, through successful exploration and production, can create more value for investors independent of the base metal—one reason that gold-mining stocks tend to outperform the base metal when the gold price surges (and underperform when gold falls).
In 2016, for instance, gold finished the year up 8.6%, but the VanEck Vectors Gold Miners ETF (GDX) surged 53%. So far this year, it is up 12%. The VanEck Vectors Junior Gold Miners ETF (GDXJ), which tracks smaller, riskier mining companies, is up 15%.
Among the bigger gold-mining stocks, Barrick Gold (ABX) began its restructuring three years ago by cutting costs and has now shifted toward improving production. In February, it reported fourth-quarter profits that beat estimates and raised both its production outlook and its dividend. Barrick is expected to focus on development projects in Nevada and Lagunas Nortes in Peru, and the improving free cash flow will help reduce debt and the need to offload noncore assets outside the U.S.
The company “has been surprising to the upside, which in our view can continue and is not reflected in the numbers,” notes Credit Suisse analyst Anita Soni. Shares recently traded at 1.43 times Barrick’s net asset value versus 1.56 times for its peers. Credit Suisse’s price target is $25, roughly 30% above current levels around $19.