The past few years have been lousy for gold and related equities with few exceptions. Gold miners have been hit especially hard, as they’ve been impacted by more than just falling gold prices. Production costs have risen. Political risks have suspended several outstanding projects. Capital has been much more difficult to come by as investors expect the gold price to fall further. As a result, over the past five years while the gold price is roughly flat the Market Vectors Gold Miners ETF (NYSEARCA:GDX) has lost 58% of its value.

There are a lot of gold miners out there and not all of them have faced these problems. In fact some of them have improved their positions substantially in the past 5 years. Unfortunately, bear market selling is indiscriminate, and many of these companies’ stocks were overvalued in 2011. Investors who locate such opportunities will find that they are often very inexpensive due to this indiscriminate selling.

Assuming gold hasn’t bottomed we could very well see another round of heavy indiscriminate selling. But I think some gold stocks have bottomed and are in clear uptrends. Some of them are cheap companies that are rapidly growing their fundamental valuations through asset accumulation and optimization, asset divestiture, and with a little bit of luck: deposit discovery and expansion. These companies are poised to benefit tremendously from the next leg of gold’s secular bull market–an event that is all but inevitable, albeit impossible to time.

Before assessing gold miners and strategies for owning them it is important to know the reasons to be long of gold generally. I will get to mining companies in part 2.

Why Gold?

Gold has been in a relatively clear downtrend since 2011, although it is in a much longer uptrend and it trades at multiples of its 1999 bear market trough of $255/oz.

Furthermore, in spite of the fact that gold has performed so well over the past several years we are only beginning to see a rise in demand from the biggest source, namely central banks, which only became net buyers in 2009 after the financial crisis.

Note that the PBoC has not announced an increase in its gold holdings since 2008 when it announced a near doubling from the previous year to 1,054. Yet many speculate that the PBoC has actually been the world’s largest buyer. I’m not sure if there is hard evidence of this fact, but there is strong circumstantial evidence, the existence of which is arguably best explained by large PBoC purchases.

The strongest piece of evidence of this buying is the surge in China’s net gold imports over the duration of the 21st century, but especially since the financial crisis. This is on top of record gold production in China–now the worlds largest gold producing country.

As a result of these developments, the Chinese gold market has become enormous.


We have also seen Chinese companies invest in gold mines, as in the recent case of Zijin Mining taking a stake in Pretium Resources (NYSE:PVG), which owns a massive advanced stage low-cost project–Brucejack, and one of the largest undeveloped resources in North America–the Snowden Deposit, which will be incredibly valuable in a high gold-price environment.

Clearly the Chinese want gold. I won’t go into their long-term plans here, as I’ve already done so elsewhere, but it is evident that Chinese officials want to use their large and growing gold hoard to exert greater influence on international monetary policy (e.g. they want Yuan inclusion in the IMF’s Special Drawing Rights currency basket).

This more than offsets tepid demand in the West, although the relative lack of interest in gold among Western investors is worth mentioning briefly. The fact that the gold price failed to respond to bullish catalysts has created negative market sentiment among Western investors. This sentiment is evidenced well by the recent “Gold Prices Buried” piece released by The Economist, which effectively says that there are too many good assets to buy for gold to be attractive, and that only the financially inept–e.g. Vladimir Putin–are buying gold.

But the biggest driving factor going forward is money creation. The recent quantitative easing program generated an unprecedented amount of newly created money, although this money has not found its way into the gold market because it has been sitting on commercial banks’ balance sheets, and in bonds and stocks. Given the rise in the stock and bond markets the latter two are self-evident, especially given the rapid debt issuance by sovereign and municipal governments. We can see evidence of the growth of commercial bank cash reserves—the primary home for newly created Fed money–in a comparison of a chart of commercial bank cash reserves and the monetary base. Both charts are courtesy of the St. Louis Fed.



Fed money creation and the gold price had also been correlated for the first part of the 21st century, only to decouple upon the Fed’s QE3 announcement in 2012.


This decoupling reflects a rise in naked short selling of gold futures and the fact that low and (more importantly) falling interest rates make stocks appear to be very attractive compared with bonds, and higher yielding bonds appear more attractive compared with lower yielding bonds.

So What Will Send Gold Higher?

A situation with a falling gold market along with rising stock and bond markets engenders bearish sentiment in the gold market. But the money supply is rising, and this will precipitate Dollar and Dollar-denominated asset selling and gold buying so that the pre-QE3 correlation between a rising global money supply and gold will reassert itself. Net central bank purchases of gold and Chinese efforts to establish the Yuan as a currency to be used in international trade are evidence that this is already taking place. Unfortunately we aren’t seeing any direct impact in Dollar-denominated or Yuan-denominated gold (although the strength in gold in terms of virtually every other major global currency is worth pointing out).

So we don’t know when the gold market will respond to these bullish catalysts, and as I write this the trend is still against gold: stocks and bonds are rising while gold is making lower highs and lower lows. But the potential for these bullish catalysts–especially the rise in the money supply–to drive gold prices substantially higher is unparalleled looking at nearly 100 years of history. Consider that the ratio between the monetary base and the value of U. S. gold is at an all-time low.


Money supply isn’t the only factor that impacts the gold price or the Dollar’s purchasing power (demand for money is the other factor) but over the long-term it is a very good indicator.


Will we see a bottom in 2015? I don’t know, but I think the risk/reward is heavily skewed towards gold bulls and against the bears. In order for gold to reflect the rise in the global money supply we’ve seen over the past several years it would have to rise substantially. I think we will see not just a mean reversion but an overshoot, so that market euphoria creates a situation in which gold is overvalued relative to the money supply, and since gold is cheaper than it has ever been relative to the monetary base the overshoot could be more substantial than it was in past gold bull markets.

How high is this? Consider that in the 1970’s bull market the value of the U. S. gold hoard peaked at 5X the monetary base, or nearly 20X the current ratio, meaning that if gold were to hit the same peak we could easily see $20,000/oz. gold or higher.

The downside would have to be considerable, and considerably likely, if this reward weren’t worth pursuing. Since gold is already inexpensive relative to the monetary base and to other data points (e.g. the cost of production) it is difficult to imagine any more downside fundamentally. Nevertheless the gold market is making lower highs and lower lows while risk-free interest rates (i.e. Treasuries) are still incredibly low, making many stocks and bonds attractive on a relative basis. This is a status quo I want to bet against longer term, but it is impossible to know concretely what will shift the market direction and when this will happen.

I don’t think we will see gold trade below its 1980 high and strong support level of ~$850/oz. I know it sounds like a long fall from $1,200/oz. but relative to the upside it is tremendous. Furthermore this is a worst-case scenario and a price we might only see for a few hours or days. The low might be $1,000/oz., or it might already be in.

This article first appeared at on May 26th, 2015.