I talk about real rates all the time, stressing that negative (and, better yet, falling) real rates are the most important fuel for gold. So what’s going on? Real interest rates are very negative and falling but gold isn’t rising.
Real rates have been falling since late 2018. That decline is why gold had started to pick up steam before COVID. Then the pandemic hit and central banks slammed interest rates to zero, pushing real rates (which are interest rates corrected for inflation) well into negative territory.
As the pandemic took hold real rates kept falling, hitting as low as -1% in July (for the 10-year inflation protected treasury, which is what I charted above). From then through to December, real rates rebounded the tiniest bit before falling again in the last three months. The recent decline happened because inflation (or reflation – inflation caused by stimulus) expectations ramped up as soon as vaccines arrived.
As I noted, the chart I’m using as a proxy for real rates is the Inflation-Indexed 10-year Treasury yield. As the name implies, it’s the yield on the 10-year Treasury corrected for inflation, which means they subtract expected inflation over the same timeframe from the yield.
The starting point of that equation – the yield on the 10-year Treasury – is what we call a nominal yield. It’s the headline yield that the note gives out, not corrected for what inflation will steal over the duration. Real yields should matter more than nominal ones…but that’s not always how it plays out.
Such is the case of late: it seems like traders are more interested in nominal yields than real ones. I think that’s because there’s such a debate over inflation expectations. Inflation should be a shoo-in, given the piles of money printed and a recovery economy. But one major barrier stands in the way: money isn’t moving.
You can see that (1) growth and velocity of money usually correlate and right now money is not moving and (2) velocity is historically low. Super low velocity diminishes the stimulus effect from fiscal programs; as happened after the Great Financial Crisis, we may be headed for another round of inflation for financial asset prices that does not play out on Main Street.
The debate around inflation is, I think, one reason why the market is mostly paying attention to nominal rates today – they are what they are, whereas you can only calculate real rates if you think you know what inflation is going to do! And rather than falling, nominal yields are rising. Here’s the 10-year yield not corrected for inflation. It’s climbed from just 0.5% in August to 1.3% today.
That rise has been a headwind for gold. In particular, gold has been getting hit whenever yields rise through a psychological barrier. The sudden valley in the gold price yesterday morning? Happened just as the nominal yield on the 10-year Treasury hit 1.25%. Gold recovered most of the dip but then ground lower through the day to end up in the valley again. Sigh
Gold took a similar hit when the 10-year yield approached 1% in November. During that month the yield rose, stepped back, rose, stepped back, and then rose again to kiss 1% for the first time since the pandemic. In that month gold dropped from US$1940 to US$1762 per oz.
Why are nominal yields rising? Remember, yields rise when bond prices fall, i.e. when there are more people selling bonds than buying. So why are people selling bonds? I think there are two reasons: an abundance (oversupply?) of bonds, already and even more so as the government works to fund another $1.9 trillion in stimulus, and a preference for stocks to position portfolios for a recovery.
On the first point: the market is trying factor in the full impact of almost $2 trillion in stimulus spending. That will pile on supply in an already-full bond market. In fact, the idea of the government issuing trillions more in bonds when a recovery is already underway has people wondering whether the bond bull market is over.
I don’t think it is. I think safe money has to own bonds and will go back there. The chart below shows the iShares 20+ Year Treasury Bond ETF (TLT), which is mixed bag of Treasuries with maturities greater than 20 years. I could have chosen any bond ETF because to show the same thing: a 15-year bull run. But there are notable pauses within a bull market, as the chart also makes clear, and it feels like that’s where we’re headed at the moment.
On the second point: I think investors are seeing – or wanting to see, but that’s another topic – signs that the world’s economy is recovering. That shift very much encourages stocks, not bonds. Even relative safe money is being drawn to the stock market these days, because the idea of coordinated global fiscal and monetary stimulus plus vaccines will create growth is seen as a pretty safe idea.
It all encourages investors to ditch bonds and buy stocks. And it’s not happening only in the US: 30-year yields in the United Kingdom hit their highest level since COVID after the country hit a vaccination milestone while Germany’s yields have been marching upwards as well.
So. Stimulus and excitement over the pending recovery is pulling investors from bonds to stocks. The same can be said for gold: investors are finding stocks more exciting. I think there are two sides to this aspect.
The junior side of the gold/silver space is high risk speculation, with potential for big rewards. The thing is, this kind of gambling is available across the market right now – and other areas, like tech stocks and cryptocurrencies, are generating better and more immediate returns. That’s a hard battle to fight and gold-silver juniors are, for the moment, losing.
The senior side of the mining space is not about speculation. It’s about (1) leverage to rising metal prices and (2) robust balance sheets and strong dividends. And this side of the ticket keeps working.
Sure, gold isn’t rising right now but the big money likely to buy major miners to get leverage to rising prices is reasonably patient; a good amount flowed to precious metal miners last year and the inflows will resume when gold and silver shine again. In the meantime, copper is sure shining and nickel is kicking butt.
Will base metals take over from gold for the next while? Looks likely.
For copper, we have a long list of drivers:
- Positive sentiment around global growth/reflation
- Infrastructure-focused stimulus adding demand
- US$ weakness expected
- Expectation that central banks will remain accommodative for quite some time
In the near term, we have a very tight physical market (both concentrate and refined metal is extremely limited, as evidenced by cash-to-3month spreads in firm backwardation). We have potential for supply disruptions in Peru and Chile as both countries head towards major elections. And we are seeing dollar weakness as Biden drives his stimulus package forward.
I certainly need more copper exposure in the portfolio and so am buying XXX. I will explain the details in full next week but for now – I’m buying.
On the nickel front I recently invested in a private company that was just accepted as the preferred bidder on a massive old mine in Botswana. It’s my big nickel bet (and Premium subscribers had the opportunity to invest alongside in the private financing). I continue to look for attractive public company nickel opportunities that I can outline here.
Going back to my list of why investors buy major mining companies, the second point was ‘for robust balance sheets and strong dividends’. This deserves more attention.
In fact – get ready to hear me harp about this for the next while, because I think this is a very important force that’s evolving in the mining space. As long as gold and silver stay reasonably strong, precious metal miners are printing money. And this time around they are committed to giving big portions of that cash back to investors.
Just this morning Newmont increased its quarterly dividend by 38% for $0.55 per share. That equates to 3.8% annualized yield. The move came because Newmont has committed to paying out 40% of its free cash flow and to adjusting its dividend policy whenever gold move by US$300 per oz. up or down quarter over quarter (its last dividend was based on US$1500 gold).
Only a company that is both in a net cash position and is printing money can give shareholders $1.7 billion on 2021. The company is also buying back up to $1 billion in shares.
And Newmont is not alone. Rio Tinto will hand investors the largest dividend in its 148-year history (!) after iron ore prices climbed 85% last year. BHP and Glencore also announced significant dividend boosts, supported by iron ore, copper, and coal prices.
These are
- Shareholder-focused moves, which is very different from the bull market when majors put their money into ridiculously overpriced acquisitions and capital projects. They will still buy and build projects, of course, but the focus has clearly and thankfully shifted back to shareholders
- Almost unique across equities. Net cash? Strong dividend yields? Buying back shares? Can you name another sector this financially robust and shareholder focused? The average dividend yield across the S&P 500 is just 1.5% (and falling)
That miners are approaching this bull market differently than the last is really important. The last time metal prices soared, mining investors got left out. This time the focus is back where it should always have been: on making money and sharing it with shareholders.
And this focus is even more important today because investors seeking yield or trying to avoid debt or who simply want stocks with tangible, bullish fundamentals have very few options. I really think this will make miners shine over the next few years. Gold doesn’t have to soar; copper doesn’t have to ramp higher. At anything close to current metal prices, miners are printing money and giving it to shareholders.