Considering gold amid rising inflation

Investors who are considering gold for their portfolios face the difficulty of assessing its recent price moves and forecasting future ones as the economy recovers.

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Market sentiment for the precious metal is mixed, “with a healthy debate around the outlook for interest rates versus inflation expectations in the coming quarters and years,” said Daniel Greenspan, senior analyst and resource team director with CIBC Asset Management, in a late June interview.

That debate will be a key driver of gold’s price ahead, Greenspan said.

The price made some interesting moves in recent weeks. In the second quarter, it strengthened by about 5% through mid-June, Greenspan noted, and hit a high in the quarter of more than US$1,900 an ounce. It then pulled back.

At the same time, U.S. 10-year Treasury yields fell to 1.4% from 1.7% in the quarter, and more recently to 1.2%. Falling nominal yields and rising inflation result in a drop in real yields; yet, a corresponding material increase in the gold price hasn’t been observed.

The lack of a strong relationship between real yields and gold “has us worried that the path of least resistance for gold may be lower from here,” said Richardson Wealth in a report on Monday that considered the influences on gold.

Still, the bullish case for gold is persuasive: consumers flush with cash and pent-up demand will help drive inflation during the post-pandemic recovery. A contributing factor is rising input costs, such as those for energy and corn.

“The strength in commodity prices increases production costs for finished goods, which are expected to be passed on to consumers where possible,” Greenspan said.

The resulting inflation, in a lower interest rate world, should be supportive for gold’s price, he said.

Alternatively, inflation could be transitory, driven by bottlenecks in global supply chains, and nominal interest rates could outpace inflation. “As a result, real rates [would] rise, which should be a headwind for gold,” Greenspan said.

His medium-term outlook aligns more with the first scenario of increasing inflation driven by consumer demand and higher input costs — though he said he’ll continue to monitor inflation versus nominal rates to assess whether real rates remain supportive for gold.

He noted that the Federal Reserve said it would reverse its low interest rate policies sooner than originally expected, potentially raising rates in 2023 rather than 2024. The Fed issues a policy statement on Wednesday, following a 5.4% jump in U.S. annual inflation in June — the fourth consecutive month of large price increases.

“Considering the depth of the uncertainty caused by the pandemic, we expect monetary and fiscal policy to err on the side of looseness,” Greenspan said. “Therefore, we expect the gold price to be supported in the second half of 2021 and into 2022.”

Richardson Wealth said it expects inflation to eventually settle at a higher level than the market expects, “which should be positive for gold” beyond the near term.

“Overall, we are still constructive on gold for a portfolio diversifier but with a more sombre view in the coming months,” it said.

Among Greenspan’s stock picks in the large-cap space is Denver, Colorado–based Newmont Corp., a “high-quality” producer with consistent operations, a “credible” pipeline of growth projects and a “strong” balance sheet, he said. Further, “Newmont’s been a leader on capital allocation policies and has a strong ESG profile.”

Greenspan also had a favourable view of Toronto-based Barrick Gold Corp., though it significantly underperformed Newmont over the past year. While Newmont has led on capital allocation and strategy, “Barrick could catch up and narrow the gap,” he said.

He described Barrick as a “low-cost, consistent operator” with exposure to Tier 1 gold assets. “The company has integrated recent transactions well, and, while there are risks around [mergers and acquisitions], we recognize the stock offers good exposure in a strengthening gold price environment.”

Thirdly, he cited Toronto-based Kirkland Lake Gold Inc., with its low geographic risk exposure — all its mines are in Canada and Australia — and strong balance sheet. Over the medium term, the company’s optimization of production at Detour Lake in Ontario could drive value for the stock, he said, as could completion of the new shaft at the company’s Macassa Mine (also in Ontario).

In the mid-cap space, Greenspan’s top pick for potentially higher returns was Cayman Islands–based Endeavour Mining, a West African gold producer with operations in Burkina Faso, Cote d’Ivoire and Senegal.

While West Africa is a higher-risk jurisdiction, “The company has been in the acquisition stage of growth, and we believe that as it transitions to free cash flow, the stock will re-rate to reflect the potential cash flow from the asset base,” he said.

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