Now is the time for contrarian investors to consider making a move, as asset classes are becoming increasingly overlooked.
Although market timing is important, it’s not the only factor to consider when making investments. I believe that there are a number of systemic risks at play right now which could lead to increased allocations in gold mining stocks and physical gold. These risks include inflation, recession, food and energy shortages, and escalating hostilities in Eastern Europe.
Reducing inflation will not be easy. The historic rise in consumer costs was likely years in the making due to global central banks’ uncontrolled money-printing and significant supply chain disruptions linked to pandemic quarantines. In addition to rapid rate increases, austerity measures may be required to dampen demand.
Historical Parallels
It’s worth noting that we haven’t seen inflation this high in more than 30 years. This encouraged then-Federal Reserve Chairman Paul Volcker, who raised rates to 19 percent, to take similar action. When measured in today’s dollars, gold rose to an all-time high of $835 per ounce, or about $3,000 in today’s money.
As I’ve previously demonstrated, gold frequently exhibits an inverse relationship with real rates. When inflation-adjusted rates have dipped below zero, the precious metal has frequently risen as investors fled government bonds in favor of gold and other hard assets.
Although today’s real interest rates are just as negative as they were in 1980, the gold price has yet to exceed $1,800. In comparison, its nominal high was set at $2,073 an ounce back in August 2020. When taking inflation into account though, its true high value is around $3,000.
Strong Dollar Has Contained Gold
The strong US dollar versus other global currencies is the reason I think we haven’t seen gold break to a new record high this year, in light of the systemic risks. Gold is valued in dollars like most other commodities, so when the greenback’s value is high, it has an impact on the metal’s price.
The only significant currencies to have advanced in value relative to the greenback so far this year are the Russian ruble and Brazilian real. The majority of currencies have decreased in worth, with the Turkish lira falling about a quarter of its value versus the dollar.
The Turkish lira has fueled the price of gold, which has been confined to a tight range in dollars. The gold price in Turkey has quadrupled over the last three years and is now near an all-time high, lending credence to its perceived function as a hedge against monetary debasement.
A Contrarian Play
When it comes to precious metal miners, I see them as a potentially lucrative opportunity right now. They’re currently trading at a significant discount to the broader equity market, and the dividend yields are at their highest level in nearly a decade.
What I believe would be of benefit to miners is a potential pivot by the Fed and Jerome Powell. We’re now in a tightening cycle, with an additional 50- to 75-basis point rate increase expected in September. However, as soon as the central bank is confident that price inflation has been tamed, policy may quickly change back to being accommodative to avoid an even more severe economic downturn. That would be welcome news for a capital-intensive, highly leveraged business like mining.
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