What Can Alchemists Say About Gold? / Commodities / Gold and Silver 2018

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.

MonetaryPolicy 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 Barcelonaon  October 16, 2017. He starts with theobservation that the last ten years were quite odd for the advanced economies.Both productivity and wages are low. The process of sustained economic progresshas been hampered. The policymakers’ idea here was to help economies that hadhigh levels of private debt adjust to lower levels of private debt withoutfalling off a cliff-edge, so the interestrates were lowered to zero, but it didn’tboost production.

The author presents an interesting argument behind thestubbornly low interest rates. The share of Asian economies in the world GDPincreased substantially over the last 20 years. This is very important, asthese emerging countries have different preferences over savings and investmentthan the advanced economies. Hence, realinterest rates decreased, increasing asset pricesand generating challenges for monetary policy. If Chadha is right, low interest rates should stay with us, whichshould provide a support for gold prices.

Conclusions
The bottom line is that the LBMA has recently releasedthe new edition of “Alchemist”. As always, it includes several interestingarticles. The three most important take-home messages are as follows. First,silver seems to be undervalued relative to gold. Second, gold shares canprovide some leverage relative to bullion prices, but the growth potential ofmining companies is limited due to the focus on cash flow and reduction incapital spending. Third, low interest rates could be more permanent than wethought, as Asian economies have a different propensity to save. It should bepositive for gold, which does not like high yields. Staytuned!

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Arkadiusz Sieron
Sunshine Profits‘ MarketOverview Editor

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