Market Update April 2020
Total Federal Debt Outstanding to Gold Price – Historically High Correlation
We have shown this chart before, but with all pretense, in our opinion, of fiscal and monetary policy discipline now out the window, it is important to focus on the highest correlation the gold price has had since President Richard Nixon stopped allowing foreign governments to redeem U.S. dollars for gold in August of 1971 and that is to Total U.S. Federal Debt Outstanding at .9078.
It’s Official – Helicopter Money Has Arrived and Along with it Modern Monetary Theory
Former Federal Reserve Chairman, Ben Bernanke, garnered the nickname “Helicopter Ben” when he commented that deflation was not a concern since the Federal Reserve had the printing press and could use “helicopter money” to fight deflation, basically print money to hand out to individuals and monetize budget deficits. The Federal Reserve and U.S. Treasury have indeed brought out the “helicopter money” playbook with the COVID stimulus package and asset purchase programs. To us there appears to be an almost giddiness among policy makers on both sides of the aisle that the COVID crisis will allow unfettered access to the sovereign treasury (printing press). Ironically, when progressive politicians on the left embraced Modern Monetary Theory (print whatever is necessary) in order to justify cost of living checks, free higher education, fight climate change and free healthcare, it was characterized (and rightfully so in our opinion) as nothing more “kook economics”. It appears to us “helicopter money” is the forerunner to full adoption of Modern Monetary Theory for as long as the markets allow it. As James Grant of Grant’ Interest Rate Observer once said, “If it is so easily reproduced, what is it worth?” referring to the U.S. Dollar when the Federal Reserve embarked on its first round of Quantitative Easing (QE) in 2008.
Dow Jones Industrials/Gold Ratio
- Underperformance of gold relative to stocks is beginning to change in favor of gold with a significant break in the ratio chart.
- A ratio of the DJ Industrials to gold indicates that the Dow has outperformed gold since 2011.
- The Dow / Gold Ratio has reached 1.00 (one ounce of gold buys one unit of the Dow ) twice before in 1932 and 1980.
COVID Impact on Gold Mining and Global Newly Mined Gold Supply
Several precious metals mining companies have placed all or a portion of operations on care and maintenance over the past couple of weeks in jurisdictions that deemed mining as non-essential. Some countries or provinces have deemed mining to be an “essential” industry and have allowed operations to continue uninterrupted. At this time, we estimate 15% of global gold production will be offline for approximately six weeks, a reduction of 450 tonnes of newly mined gold supply. Considering the daily turnover in the gold market in London and Zurich is between 900 and 1000 tonnes, we do not anticipate the reduction in supply to influence prices.
For the gold miners experiencing production suspensions, the loss of revenue and costs of care and maintenance will negatively impact Q2 results. That said, it appears the market is willing to look past the suspensions considering share prices of gold miners are already historically depressed versus gold (see Gold/XAU ration chart). For the gold mining companies that are able to operate with minimal disruption, we would anticipate the combination of lower fuel prices along with record local gold prices in many gold producing countries to provide robust operating results.
Precious Metals Equities Versus Gold – Historically Cheap
The temporary Covid related suspensions and the rush for liquidity in early March, has led to historically attractive valuations of precious metals mining equities. As of April 7, the ratio stood at 18.5. In our opinion, the ratio should contract as the market starts to appreciate the gold mining industry has made significant strides on focusing on building shareholder value through capital discipline rather than being just options on the gold price. We believe this should also lead to the market revaluing gold reserves in the ground to higher levels which we believe is one of the components necessary for the Gold/XAU ratio to recapture pre 2008 levels.