As you can see above, the current market narrative is certainly all about the reflation trade, not the store of value trade. While both gold and copper miners are up on the year, gold miners are still consolidating below a peak in early August, while copper miners are at the highs. Gold miners are up about 24% on the year vs copper miners up 44%.
Part of this can be seen as a deep value trade, as both indexes are still down over 50% since 2011, but part of this is also a disagreement on the nature of the inflation that we are going to see from record central bank balance sheet expansion worldwide. I’ve made no secret that I’m firmly on the store of value side … I see way too much money chasing a shrinking stream of investment opportunities, with valuations that make as much sense as negative interest rates.
Milton Friedman famously said “inflation is always and everywhere a monetary phenomenon.” This phrase has long been oversimplified with unrecognized implicit assumptions and interpreted as hyperinflation is coming because the federal reserve balance sheet went up again. Any serious investor should know that predicting the outcomes isn’t quite that easy.
The size of the federal reserve balance sheet has been rising substantially over the past 12 years. How did assets respond:
- Between September and December 2008, the balance sheet more than doubled:
- S&P 500: Intermediate bottom November 2008, bottom in March 2009, and didn’t recover to former highs until 2013.
- Copper miners: Bottomed in November, had a higher bottom in March, and peaked out in early 2011.
- Gold miners bottomed in November, had a higher bottom in March, and peaked out in late 2011.
- Between Oct 2010 and Jan 2015, the balance sheet nearly doubled:
- S&P 500: After a false start from Oct 2010-Oct 2011, it nearly doubled by 2015
- Copper miners: Up 50% from 2010-2011 to a glorious peak, then collapsed to a third of that peak by 2015.
- Gold miners: Up nearly 50% from 2010-2011 to a glorious peak, then collapsed to a third of that peak by 2015.
- Between 2015 and 2018, the balance sheet stabilized. Then it went down 20% by Aug 2019.
- S&P 500: Rough & flat from eary 2015-late 2016, then shot up 40% by Jan 2018, then rougher and flat thru Aug 2019.
- Copper miners: Hard bottom in 2016 down 85% from the peak, more than tripled thru Jan 2018, then down by half in late 2019
- Gold miners: Hard bottom in 2016 down over 80% from the peak, up 2.4 times thru Jan 2018, then down by a third in late 2019
- In September 2019, the fed sharply reversed course. Then the pandemic it and the balance sheet doubled from it’s 2019 low. Aside from the pandemic lows that all 3 asset classes hit in March, we have:
- S&P 500: Up 25% from Aug 2019 at new all-time highs
- Copper miners: Up 87% from Aug 2019, still less than half the 2011 peak
- Gold miners: Up 39% from Nov 2019, still nearly half the 2011 peak
What conclusions can we make here? The answer isn’t as simple as you’d think. These asset classes all have long-term cycles to consider. Stocks seemed to respond the best to the Federal Reserve’s quantitative easing this last decade, but they also had an enormous prior consolidation with a peak in 2000 that was barely exceeded in 2007 finally broken through in 2013. Gold and copper did terrible in the 1990’s, shot up like a rocket from 2000 to 2011, then did terrible in the following decade.
Here’s a summary of my thoughts on it:
- S&P 500: I don’t this asset class after a decade-long run to new highs. I just feel like a consolidation is more likely than a continuation after this run. Add to that an environment where incomes have gone nowhere for decades, small companies are forced to shut down and starved of cash while the big companies have been given practically limitless access to capital, and the trend of globalization has been reversing. I think we’re about to start a new cycle both politically and economically.
- Base commodities: I still don’t see how these can do well if demand is low. I want to see huge cities build annually in China like around 2010, or tanks and planes being built like crazy. Instead we see planes sitting idle, massive unemployment, and governments that are too worrried about the cost of throwing more rice to the peasants to consider any major infrastructure projects. That being said, I will be watching commodities like a hawk because a sharp downturn in copper is often followed by a sharp downturn in gold a few months later.
- Precious metals: I see everything lining up for the short term here. A solid period of consolidation below the highs, a good time seasonally, and world trade starting to ease into more currencies than just the US dollar. Add to that a huge supply of money looking for investments through stocks and bonds that are priced at all time highs despite an extremely weak economic backdrop.
- Commodities including precious metals do not behave like stocks, so be careful! The S&P 500 has a continual passive bid from people’s 401k’s which gives it a much more steady climb in bull markets. Commodities and precious metals don’t have this endless and impartial bid to buy, and they are much smaller markets by valuation. Because of this, they behave in fits and starts with much wilder swings.
This past week has been really great for me because of my heavy allocation to gold miners and silver, as well as my significant allocation to bitcoin and etherium. Silver seems to be breaking out nicely, while gold is weaker but I expect it to follow. At the same time, I have been getting more and more nervous about how sustainable this stock market rally really is. I dumped the CRM which I bought the week prior for a small loss … I just didn’t have conviction on the trade. I looked down from the sky-high tech valuations and got spooked. BDX had some nice gains so I sold my positions there as well. CCJ shot way up and I looked at why … Uranium went up in value because Cameco had to temporarily shut down a mine due to a covid outbreak. I sold my position there for a nice gain as I couldn’t wrap my head around why a stock would go up because the underlying company had a covid outbreak. I’m still invested 100% and then some … aside from reducing margin leverage considerably, I bought an IWM put and invested the rest toward my gold miner plays.
Here’s where I’m sitting:
- 32.9% Gold Miner Stocks (Large)
- 19.1% Gold Miner Calls (Large)
- 17.0% Gold Miner Stocks (Jr)
- 6.0% Gold Miner Calls (Jr)
- 3.2% SLV
- 10.5% SLV Calls
- 0.9% TLT Calls (20+ year US treasuries)
- 8.7% IWM Puts (Russell 2000)
- 1.8% EEM Puts (Emerging markets + China)