Note: This text is a translation from the original language, German.
Proven Inflation Hedge
Gold has proven to be an inflation hedge for thousands of years, and even though the performance of the precious metal has been disappointing this year, this can quickly change. The lackluster performance is partly due to the very strong US dollar and the extremely hawkish policy of the Federal Reserve. The Fed is responsible for a scenario in which market participants believe it will do everything in its power to combat inflation. Often, comparisons are made to the era of former Fed Chairman Paul Volcker when interest rates rose from 11% to over 20%. We consider this very unlikely because interest rates have already been raised significantly more in percentage terms than during Volcker's time, and states, businesses, and households are now much more heavily indebted.
Illusion of Control
The economic situation, considering a global recession and the debt situation, will leave central banks with no choice but to refrain from further raising interest rates or even to slightly lower them in the medium term. The moment when investors realize that precious metals are indeed a good hedge against inflation and that central banks can no longer maintain the illusion of control over inflation should present a unique opportunity for precious metals. When examining the development of gold this year in various currencies, differences become apparent. While the price of gold has fallen by 7% in US dollars, it has risen by 6% in both the Euro and, for example, the Australian Dollar. While the gold price and, in turn, revenues for producers have increased, the share prices of gold mining companies, for example in Australia, have declined by over 28% this year - a significant discrepancy that cannot be explained solely by increased production costs. On average, these costs have risen by around 10%. However, the largest cost component in the industry is labor expenses. The initial costs for new mines planning to start production in the coming years have also increased significantly. This is likely to delay some production launches and continue to negatively impact the supply.
A positive point for contrarian investors is the current sentiment in the gold mining sector. In September, the two most important conferences within the sector took place. While a gold price of $1,700 per ounce would have caused true euphoria a few years ago, this time there were many dissatisfied voices. Despite excellent quarterly results, many mining company executives were rather downcast. The primary reasons for this were the share price losses, which were not at all rewarded by the market and investors, despite the outstanding performance.
Article from Smart Investor 11-2022, Guest Contribution by Tobias Tretter.