Why Gold (and Gold Stocks)
Are Going Up in 2020
NEGATIVE INTEREST RATES: They’re Likely Here To Stay…and…
They Put A Long-Term Bid Under Gold
The financial world is struggling to make sense of negative interest rates. It’s a phenomenon that nobody has any history with. There’s no precedent, no playbook or instruction manual that outlines what happens to people, jobs, savings, asset classes etc.
I see articles weekly (if not daily) across the financial press trying to make sense of it all.
But what if the factors were pretty simple, and had to do more with real people than ivory tower finance moves like weird, interconnected derivatives?
That’s what I think. I’ll outline my thinking below. But I want to tell you up-front that two of my biggest conclusions are…
- Negative interest rates are here for longer than you think
- Negative interest rates should put a BIG bid under Gold
KEEPING IT SIMPLE—AND REAL
You might be surprised to hear that it’s not uncommon for REAL interest rates—all over the world--to go negative i.e., long-term interest rates minus inflation. Particularly, during slowdowns like we saw in 2012, and we also got there in '16 but we never quite had a recession.
We're getting there again but what we have today, despite people saying interest rates are too low--and it feels too low--real yields have been lower two times since 2012; a good 50 basis points lower.
So many of the recent trends aren't captured in headline CPI-based (Consumer Price Index) inflation.
Urban dwellers can now use Lyft and Uber instead of having to buy and maintain a car. That’s a massive cost savings. CPI doesn't include the substitution of Uber for owning a car. It looks at the price of a car.
Just think how many things we use now that either cost less or have made our lives so much more efficient. It doesn't look at how quickly you get to work using GPS on Google Maps, or with the flex arrangement you now have where you don't even have to drive to work four days a week.
And think of the online delivery that Amazon gives you—if I order a book at 9am, it’s usually delivered by 4 pm that same day. Efficiency = deflation.
There is the advent of things like GPS and home automation, and streaming services, and improvements in cars--there's just been this technological leap that has created a lot of cost savings, which also means deflation.
DEMOGRAPHICS SINKS INTEREST RATES
Technology deflation is the first cause of perhaps inflation running much lower than headline numbers suggest.
The second, I would suggest, is what The Fed likes to call “time pref” or what I would call demographics.
The western world is getting older. An aging population brings a greater adversity towards risk. As you get older, you naturally have a greater and greater preference towards having money in the bank and saving money and future spending over current spending.
Not only does that also cool the economy somewhat, it should lead to some disinflation or lower inflation in the near term, that changes interest rate preference.
Now, retirees are willing to accept much lower long-term interest rates for the certainty of having their dollars in 5-10 years, at whatever the rates will lock in. They do not want the risk of equity markets and bond price volatility; even very low interest rates bring certainty.
But if you lower interest rates and an investor or saver is mostly using interest bearing securities (some kind of bond or GIC) to attain their goals, you then need to save more. If you are not going to have as much income from investment, your principle needs to be higher.
How these two factors are related—IMHO—is that all the technological things that are helping people save money, are also leading to an increased amount of dollars that can be saved—but those dollars are being put away—saved—by an older population who wants more certainty at any price--and that’s driving down interest rates.
I think consumers have now got used to this; there's become a greater and greater acceptance living in a world that just doesn't pay interest. Savings isn't necessarily rewarded with interest anymore as it used to be. You used to be happy to have it in ten years when you need it. I think that's also been a trend.
This new social norm of zero to negative interest rates has a couple consequences for equity investors—short term good, but long term bad, and governments are scared to death of the bad.
First the Good News—negative interest rates will initially create a favorable, pro-equity environment, for a couple reasons.
One is the bond market—bond prices go up or down inversely to interest rates. So as rates go negative, bond prices increase. And the large balanced portfolio managers are now in big profit positions with these bonds -- likely have to sell some bonds and buy some equities to balance their weighting.
(It’s a bit ironic to me that a portfolio of negative yielding bonds over the last 3, 6 and 12 months has made money as rates kept going lower—therefore bond prices went higher.**)
Equities also become worth more because the discount rate on future cash flows is essentially zero. Up until now the most accepted accounting for future cash flows is to discount them at 10% per year due to uncertainty and inflation.
But going forward, in an era of negative interest rates, that discount rate will go to 5% or less. This essentially doubles the value--of especially leading brands--in all commercial sectors. Anything that has been around for a long time and the Market thinks will continue giving a long-term cash flow—values will soar.
Now the Bad News. As negative interest rates keep going on for years, and there’s no inflation…people realize products and services will likely be cheaper next year. They come to expect that prices will come down. That then stalls purchases. If you buy a car today for $25,000, maybe in a year it will be $24,000.
Once deflation becomes expected--which is what the US is horrified of--you begin to see a big pull-back consumer spending. See Japan.
And if this continues for any length of time (for demographic reasons outlined above I think it will), it will be hard to get out of—because consumer expectations are really hard to change; they're almost generational things.
Think of how your parents & grandparents saved, or hoarded, EVERYTHING… because there was no money flow after WWII. Even as the economy improved—and it improved A LOT over the 40 years after the war, I’m sure you can remember them still clinging to odd things. That was just their mindset.
It's like when we see a major equity market pullback, like we did in 2000 and 2008, and see from investors and how it changes a risk tolerance, sometimes for the rest of their lives, but if not for 10 or 20 years afterwards.
I think the same thing is happening now, and once you set in deflationary trends and people being accustomed to zero or not interest rates, that's a really hard behavior to break, and I think that's why the Fed is so afraid of it.
To conclude this section: two factors—
- future price decline expectations
- and an inability to rely on interest rates to help you in retirement
will initially help the stock market, but will ultimately result in a sustained pullback in consumer spending and be bad for it. I think that's what Japan has gotten itself stuck in now for a couple decades, and it's a situation that is very hard to get out of once you get there.
There is ONE exception to this Bad News—stocks that represent hard assets. Hard assets should do very well. For public companies—stocks—with real assets and particularly things contracted with high returns like a midstream (pipeline) company, or a factory, or even an office space where you get nice cap rate, a nice rental yield--that's incredible because you can continue to finance lower and lower rates.
And the yield you're earning on your property--relative to what's available in the rest of the market--keeps going up, so it should make the property more valuable. REITs—Real Estate Investment Trusts—should do very very well.
Any type of hard assets, especially hard assets that are typically debt financed, should go up massively in value. Pipelines are a great example. They last for decades, and one yielding 8% (which many do now). The lower interest rates go the more people are willing to pay for ANY positive cash flow—these stocks could easily double, so that their yield is 4%.
WHERE TO FROM HERE? LOWER STILL…
Short term (as in Sept 2019) I think rates have largely stabilized. But if you look at global yields, the two real outliers are the US and Canada. US yields are in some cases two percent higher than foreign yields despite having a 1.6 percent tentative yield.
I think that provides a massive incentive for foreign capita to flock to is the US buying market.
That then leads to the stronger dollar, I think the bond market is largely to blame for the dollar strength we've seen the last couple years.
GOLD IS THE BIG WINNER
It should be quite positive for gold. Gold I think, quite properly, is seen as a store of value in inflation hedge against inflation hedge obviously, in fact of its own currency.
You start to see more and more volatility between currencies and less and less yield from debt instruments. I think that makes gold more attractive.
One of the main arguments not to own, one is that it's not necessarily institutionalized and I think nowadays it is, there are many ways to own gold with almost complete safety or risk of not losing your underlying asset, or having somebody confiscate it, or having the gold not be in a vault. Those days are kind of gone.
The other reason to not own gold, historically, has been you don't get a yield on it or you don't get a return on it. In a world with zero yield or, God forbid negative yields, having zero yield on gold can actually be a higher yield by long-term government securities.
And that's why I am buying gold stocks. In particular, this ONE stock:
- Production set to soar by 50%
- High growth yet still trading at under 3 times 2020 operating cash flow
- A gold stock trading today at just 6 times earnings
- Revenue is projected to be $500 million with EBITDA of $250 million.
- Stock has very cheap valuation vs peers
- Very profitable, cash costs of just $800 per ounce
- All-in costs of $1000 per ounce.
- Highly leveraged to gold prices (perfect for 2020)
- Low hanging fruit acquisition opportunities nearby
- One mine reserves of 2.4 million ounces with a solid 1.35 g/t reserve grade.
- No exploration risk
- Bonus report included:
- Secrets of the Schaefer Method.
- How Keith's portfolio beat the market for more than 10 years in a row.
- Get insight from one of the most successful traders in the small resource sector over the last 20 years
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