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Mr. Lequime, one would actually expect a flight into gold, given the many crises we are facing. Why is that not the case?
Georges Lequime: The most important reason can be seen in the beginning of the cycle of interest rate hikes. It is true that speculative money flowed into the precious metal with the start of Ukraine, but that was only short-term. The key factor is interest rates. We have found that there is a very close correlation between the price of gold and the yield on the U.S. ten-year inflation-indexed bond, or TIPS. While normal ten-year Treasuries still currently have a real yield of minus six percent, TIPS are now yielding 0.6 to 0.7 percent. In March, it was still minus 0.7 percent. That’s a dramatic change, and the price of gold has fallen accordingly.
Based on this, what is your outlook for gold?
Lequime: The fact that the yield on ten-year TIPS is in positive territory means that the markets are expecting a decline in the inflation rate. At the same time, there is a risk of recession. The crucial question for the gold price is therefore how the central banks will react to this. The price of the precious metal in the short to medium term depends entirely on the reaction of monetary policy in the coming months.
What scenarios are conceivable?
Lequime: Let me look at the past for this. In the early 1970s, we had the oil crisis and inflation was very high. Interest rates were raised, but the Fed was behind the curve. So we had negative real yields and gold did very well until 1980. But then there was another surge in inflation, to which the Fed, then under Paul Volcker, responded very aggressively, raising interest rates into double digits. Real yields subsequently climbed to two to three percent. Since gold offers no current income, owning gold was unattractive and the price fell.
In your view, are we now more in 1974 or 1980?
Lequime: On the one hand, we have the problem of unprecedentedly high debt. That means central banks cannot realistically raise interest rates as much as they did in 1980 without risking a systemic crisis at some point. Add to that the possibility of a recession. Then demand would weaken and inflation rates would come back. However, only the next three to four months will show how things will really go. Although it is always a good time to enter gold when the risks are high, a certain degree of caution is still advisable.
How do you assess the shares of gold miners in this environment?
Lequime: While we don’t know where the gold price is headed in the short to medium term, what we do know very well is what the average cost of production for an ounce of gold is and where the gold price currently stands. In fact, we find that the total cost of an ounce of gold is currently $1,300 to $1,400 on average, despite high inflation. So there are companies that are still making good money at the current gold price of $1,700 to $1,800 per ounce. At the same time, balance sheets are very healthy and mining companies are investing in new promising projects, unlike in past cycles.
So what do the valuations look like?
Lequime: For gold mining companies, we think the ratio between price and operating cash flow is the most meaningful. In the past, this ratio was between 15 and 20 times. Currently, the ratio is six to seven times, and in some cases it is as low as two to three times, by which the share price exceeds cash flow. The dividend yield is not as decisive, but the larger producers also pay two to three percent here. Most importantly, the price of gold doesn’t even have to rise from current levels for gold miners to make money and add value.
Can gold mining share prices rise even if the gold price stagnates?
Lequime: Indeed, there have been such periods in the past. In the 1980s, a gold fund that was very well-known at the time managed to generate a significant gain despite a declining gold price. However, one must keep in mind that it is usually not so easy for the large groups to create added value in phases of stagnating or falling precious metal prices. This is more likely to be achieved by smaller and medium-sized companies and the exploration companies, which have stronger upside potential.
Where do you see risks?
Lequime: We have the problem of decreasing ore grades at the same time that costs are rising due to inflation. That means more capital is needed. In addition, there are higher labor costs and geopolitical uncertainty factors. In Central and South America in particular, we are seeing more government intervention in mining, but in other regions, too, environmental regulations are increasing, for example, which is why it takes longer for projects to be approved. All of this poses a risk to companies. But what’s interesting is that the gold price can never fall below the average cost of production for long, because then supply becomes tighter. Therefore, a significant and prolonged collapse of the gold price below the average cost of production is unrealistic.
