What Can Alchemists Say About Gold?

Alchemists are precious metals experts, aren’t they? So let’s see what we can learn from the latest issue of the Alchemist, the LBMA’s quarterly journal.

Silver Linings

Silver has been always in gold’s shadow. Could the accelerated and synchronized global growth finally boost silver? In his article, Jonathan Butler offers two arguments in favor of higher silver prices. First, in a world of synchronized growth, silver should outperform gold, as it has a much larger industrial base. In particular, the solar sector and vehicle electrification are very promising areas for silver demand. Second, silver seems to be undervalued. Historically, one needs 58 ounces of silver to buy an ounce of gold, but now it would take around 80 ounces.

We generally agree with Butler. We don’t believe that gold-to-silver ratio has to reverse to the historical mean, but in the current macroeconomic environment silver could indeed outperform gold. However, this is not happening, as gold benefits from the safe-haven demand. And investors should remember that silver usually catches up later in the precious metals bull market.

Shares Or Metal

Michael Bedford provides an analysis of the gold mining sector. As the price of gold was rising in the 2000s, mining companies launched expansion plans financed by debt. But when the yellow metal prices peaked at almost $1,900 to fall to about $1,100, the market capitalization for the sector fell far quicker and further. In response, managers started to repair their balance sheets and improved the companies’ cash flows. This is why the total expenditure and production fell. However, some companies have over-cut capital savings – and now investment in exploration and new projects must resume.

So it is worth investing now in the gold stocks? The article suggests that not necessarily. Mining companies still prioritize cash flow, so meaningful growth seems a distant dream for some producers. And dividends are rare in this sector, with thin yields. Mining stocks may provide leverage relative to gold prices, but it’s a double-edged sword, as managers learned during the last bear market in gold.

Monetary Policy in the Era of Political Uncertainty

And we would like to analyze the transcript of Jagjit Chadha’s keynote lecture “Monetary Policy in an Era of Political Uncertainty” at the LBMA Conference in Barcelona on October 16, 2017. He starts with the observation that the last ten years were quite odd for the advanced economies. Both productivity and wages are low. The process of sustained economic progress has been hampered. The policymakers’ idea here was to help economies that had high levels of private debt adjust to lower levels of private debt without falling off a cliff-edge, so the interest rates were lowered to zero, but it didn’t boost production.

The author presents an interesting argument behind the stubbornly low interest rates. The share of Asian economies in the world GDP increased substantially over the last 20 years. This is very important, as these emerging countries have different preferences over savings and investment than the advanced economies. Hence, real interest rates decreased, increasing asset prices and generating challenges for monetary policy. If Chadha is right, low interest rates should stay with us, which should provide a support for gold prices.

Conclusions

The bottom line is that the LBMA has recently released the new edition of “Alchemist”. As always, it includes several interesting articles. The three most important take-home messages are as follows. First, silver seems to be undervalued relative to gold. Second, gold shares can provide some leverage relative to bullion prices, but the growth potential of mining companies is limited due to the focus on cash flow and reduction in capital spending. Third, low interest rates could be more permanent than we thought, as Asian economies have a different propensity to save. It should be positive for gold, which does not like high yields. Stay tuned!

Arkadiusz Sieron

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