The situation with markets could be pretty dire in the coming 6-12 months. We believe that we will have technical stagflation, where we might have employment declines while inflation rises. Rate hikes which won’t be effective in changing the real supply side constraints, exacerbated by the Russia-Ukraine situation, are the reasons we foresee this economic outcome. Gold is not a bad asset in these times based on historical precedent, and is a natural hedge against the market jitters and corrections that will come with the possible demonstration of impotent monetary authorities. People should be considering gold exposures right now given the range of economic exogenous factors introduced by war and migration, as well as market risks related to the inflationary dynamics we were seeing prior to the Russian invasion.
Is Investing In Gold A Good Idea?
Investing in gold could be a good idea right now, but in our opinion it’s never better than betting in stocks that exist as cousins to gold. Commodities aren’t cash flow producing assets, and you can buy companies that mine gold for great earnings yields. This is the Warren Buffett approach. He traditionally never took positions in gold, always taking market uncertainties as a time to load up on more equities on sale and tolerate the volatility risks, but when he did eventually do it he bought Barrick Gold (GOLD).
We’d suggest a similar approach, except not investing in Barrick Gold which will naturally have that unwanted Buffett premium from followers bidding up his stocks. By buying companies with clear gold commodity exposure, we can translate our outlook on gold into a thesis for cash producing assets, where horizon risks are limited by owning shares in a business rather than a commodity where we have to rely wholly on a speculative appreciation.
How Did Gold Do In 2021?
Nonetheless, being exposed to the commodity either directly or through equities warrants an understanding of the dynamics in the asset class.
In terms of historical performance, COVID-19 was a strong impulse for the price of gold. In addition to the immediate economic uncertainty it introduced in 2020, it led to the inflation that we have this year in 2021. While gold doesn’t always perform in inflationary environments, it does tend to and did so in 2021.
How Will Gold Do In 2022?
While the gold run was notable thanks to last year’s economic uncertainties, which indeed weren’t close to being solved this year, since we’re talking about real supply side constraints and supply side issues, the Russia-Ukraine conflict created more factors to keep the price high. The uncertainty introduced by the war, which is a culmination of growing tensions and conflict between the nations which last came to a head with the annexing of Crimea, is compounded by the fact that Russia still holds the commodity cards, controlling substantial amounts of the world’s raw materials. Palladium and other PGMs for the renewable push, timber, titanium for airframes and defense even, are all reasons why Russia has staying power in this conflict. With Ukrainian resistance holding up unexpectedly well, the conflict could last long and the impacts on commodity markets could be very substantial as Russia plays more cards to deal with sanctions and questionable support from their own people and even other relatively aligned governments.
In addition to these technical factors, there are others that contribute to the rise of gold. Gold reserves are falling in coffers and we are at a low in the mining and exploration cycle. These could push up the price of gold further from more supply side effects.
Is Now A Good Time To Invest In Gold?
Now would be a reasonable time to invest in gold, but an even better time to invest in gold miners, whose operating leverage makes them akin to a gold investment except with the downside protection of being able to provide cash flow.
In the micro-cap space you could consider the pretty interesting thesis behind Galane Gold (OTCQB:GGGOF). This company is disposing of an expiring mine and getting two new major mines that more than replace their past production up and fully running soon. They have a good track record of improving mining asset qualities and developing special situations, and the cash costs are pretty low on their assets around the $1000/oz mark.
If micro-cap is too aggressive for you (understandable), you can consider some closer to mid-cap foreign exposures like DDH1 (OTCPK:DDHLF). Their clients are mostly gold miners, and their service is contract drilling for assessing bedrock in mining deposits for exploration, brownfield expansion and even closure planning purposes. Working across a mine’s lifecycle means slightly less leverage in terms of cash flow production relative to commodity prices, but exploration revenues still come from the commodity environment being favourable, which we expect to be the case for gold. They merged with another Australian contract drilling company at a great multiple, and the company trades below 5x EV/EBITDA despite growing EBITDA and revenue, as well as a rosy picture for the gold outlook which drives their revenue.
Gold itself is also a fine trade, where you could consider a gold tracking ETF like the SPDR Gold Trust (NYSEARCA:GLD). Indeed, the technicals related to market sentiment as well as the reserves for gold spells a favourable environment for the price currently. But if you’re looking to really invest, consider gold miners like Galane, or if you want to be even more prudent, the high margin and growth contract drilling business in a fragmented Australian market, DDH1. That way if the market cleans up better than expected after this conflict, or if you are worried about Bitcoin (BTC-USD) suddenly stepping in as a better store of value (although it probably won’t take gold’s place anytime soon), you’re at least getting paid with hard cash on the basis of a gold price that will still be printing cash for miners and creating business for operators like DDH1 even if it pulls back.