By any measure, 2019 was a strong year for gold prices and investments.
The beginning of 2019 saw gold at $1,281 per ounce. By the end of the year it was up to $1,509 per ounce — a 17.8% gain.
Just a month later at the end of January 2020, it was up to $1,583 per ounce, pushing gains up to 23.6%. That was enough to beat the huge gain we saw in the Dow Jones Industrial Average over the same 13-month period.
Following the coronavirus outbreak, gold surged and reached all-time highs in late July 2020.
The question is can we expect gold prices to keep heading up and, if so, how much further can we expect them to run?
We have already seen spikes from geopolitical dramas and standoffs, the coronavirus scare, and plenty of other events as well. Headlines will always drive short-term increases, which tend to quickly fade away, but fundamentals will carry the long-term trend.
Looking at the fundamentals, there is a strong case that gold is far from done with its run in 2020. Let’s dive in and take a look.
Gold Versus the Dollar
Gold historically has been closely tied to the relative buying power of the U.S. dollar as the de facto global currency.
A whole lot of factors weigh into the important relationship between gold and the dollar as a result, with the inflation rate being a primary driver.
The price for gold has increased rapidly, but when adjusted for inflation, the purchasing power of an ounce of gold isn't far from where it was in 1980.
Gold has to be at around $2,000 per ounce to match the purchasing power of an ounce back then.
Gold, for our purposes, is an investment. As such, we should give a lot of weight to the price of gold compared with other broad investment metrics as well.
Another way to look at it is this — gold is competing with other investments only for dollars that people are willing to invest.
Gold Versus Investments
That brings us to another classic way to look at the price of gold relative to the Dow Jones Index. Here is a chart:
Going into this year it took about 18 ounces of gold to match the “price” of the Dow. The peak of the gold-to-Dow ratio came back in 1999. Gold was around $290 an ounce and the Dow was around 11,500.
The low point came at the top of the 1980s commodities boom when gold was about on par with the Dow after a decade-long stretch of stagnant markets.
As gold hit all-time highs in July, the ratio was at 14.5, making it clear that we’re not close to gold being relatively expensive.
Another more modern way of looking at this is to look at ETFs, which trend really well with general investor sentiment.
Back in 2011 when gold peaked around $1,900 per ounce, the SPDR Gold ETF was the same size as the ever-popular S&P 500 ETF. It bottomed out at less than 10% the size and is now a bit above 14%.
Precious metal mutual funds have also had a decade their managers would like to forget. According to data from Morningstar, on average they’ve fallen 5% per year.
Even with the rise in gold prices and a large influx of new capital, investors clearly aren’t investing in gold at anywhere near the same level as they have in the past.
This kind of delayed reaction is normal for all kinds of investments as they rebound. As investors reinflate fund sizes by moving into gold, we can expect significant price increases to overcome the lag they’ve seen compared with recent gold price gains.
Gold Mining Stocks
No talk of gold prices and investments should ignore a key feature of gold mining stocks — what is effectively a leveraged play.
All gold miners have a break-even point where their cost to produce gold matches their revenues. Dip below that, like we’ve seen in recent years, and it can turn into a bloodbath. Look back just a couple years and we can see plenty of evidence of that, with debt blowing up and causing drastic changes for even the major gold producers.
We’re entering a period in which that has reversed and gold prices actually create a profit multiplier.
In 2019, the average all-in sustaining costs of mining for gold miners rose to $1,000 per ounce. A company with that average cost in June 2019 would have the potential to make $273 per ounce of gold. At $1,600, the same company can make $600.
While gold went up about 22% over the same period, the money the company can make selling the same ounce of gold went up 120%.
Gold companies rarely sell anything at spot prices. Long-term contracts and other costs dictate their “wholesale” prices but also get rewritten.
Sustained higher gold prices will be trickling into projections and negotiations in coming quarters and are going to make the best gold miners cash-printing machines.
Gold Miner Reserves
Finally, we should look at long-term cannibalization of reserves while we’re at it.
Gold producers are facing an existential crisis without massive investments in exploration or the companies that are finding the best new deposits.
It takes a good decade on average of further drilling and development to get a new gold mine up and running, and that average is only increasing.
Knowing that, take a look at where we were 10 years ago and what comes next. We’re poised to enter a multiyear period where gold producers will continue to deplete resources at an alarming rate without mergers or acquisitions.
This will create a squeeze on supply as demand is increasing while also increasing the premium the major gold producers will have to pay to acquire smaller companies. It's a one-two punch.
We're already seeing a rise in M&A activity in the sector with large premiums. We're about to see a whole lot more.
2020 has been a volatile year. Economic data are mixed. Stocks are expensive. Politics in an election year will only make things worse. The Fed is taking on trillions of dollars of liabilities, and the government's debt and yearly deficit are spiraling out of control.
That makes gold a strong candidate as both a safe haven and as an investment with a lot of catalysts and factors that will push prices higher.
@AdamEnglishOC on Twitter
Adam's editorial talents and analysis drew the attention of senior editors at Outsider Club, which he joined in mid-2012. While he has acquired years of hands-on experience in the editorial room by working side by side with ex-brokers, options floor traders, and financial advisors, he is acutely aware of the challenges faced by retail investors after starting at the ground floor in the financial publishing field. For more on Adam, check out his editor's page.
*Follow Outsider Club on Facebook and Twitter.