2022 got off to a “euphoric” start, pushing gold prices up to a peak of $2,070/oz on 8th March which was just a shade below their record level ($2,075/oz) reached in August 2020. But the market has since trended back down. The war in Ukraine - along with the uncertainty it has created - remains an important support factor for the gold market, but the sharp rise in interest rates in the USA and in the rest of the world is taking a toll.

And although it is true that the inflationary outlook is yet another plus point for the gold market, the momentum is primarily being driven by real interest rates. Yet the markets are unlikely to get any reassurance from the Fed which has resolved to normalise its monetary policy rapidly, with even a potential 50bp hike in key interest rates at each of its upcoming FOMC meetings.

Despite these headwinds, however, the investment case for gold and mines still holds up rather well. Year-to-date, growth in the price of gold remains in positive territory ($, ~+1.5%) as does the trend for gold-mining stocks ($, +2%); compare this with the global equity market (MSCI ACWI NR) which has lost 17.4% ($), emphasising the benefits of diversification that gold as an asset class can offer a broad allocation strategy.

Whereas US 10Y real interest rates were negative at -1.10% at the end of 2021, they have since bounced back by more than 140bp to +0.30% which is their highest level since July 2019. Such a big jump should have taken a much heavier toll on gold prices than it has done. This seems to suggest that there are other factors at play, as well as a degree of uncertainty among investors.

The same goes for the US dollar, which is at its highest level since 2002 (Dollar Index). Such a strong dollar should also have hit gold prices harder. It would appear that we are in one of those periods of considerable uncertainty during which investors also look at the greenback as a safe haven.

In today’s highly uncertain climate, the consensus has significantly raised its expectations for 2022 and now sees the price of gold averaging $1,900/oz versus $1,716/oz estimated at the start of the year.

As far as investment flows are concerned, we can clearly see that investors are taking an interest in gold again. For instance, gold-backed ETF assets have increased by the equivalent of 260 tonnes year-to-date, thus covering 90% of the net sales observed in 2021 which was the worst year since 2013.

The World Gold Council published its closely watched quarterly report on gold supply and demand trends. It showed that gold demand was very sharply higher (+34% - 1,234 tonnes) in the 1st quarter of this year than in the same period in 2021.

The biggest trend drivers were the war in Ukraine and the surge in inflation, and this was particularly evident in the amount of gold-backed ETF assets which jumped by 244 tonnes during the first three months of the year. However, it is worth noting that this high level of ETF activity merely offset less favourable trends for other components of demand.

Demand from the jewellery sector (474t) fell by 7% (vs Q1 2021) and that for bars and coins (282t) dropped by 20%, both affected by weaker demand in China and India, while central banks also reduced their gold buying (84t) by 29%. All these components have been a drag on the gold market.

Gold demand from the technology sector, on the other hand, reached its highest level (82t) since 2018.

On the supply side, mining production (856t) reached a first-quarter record while the supply of recycled gold (310t) was boosted by rising gold prices and came out 15% higher in Q1 2022 than in Q1 2021.

What about gold mines?

The gold-mining industry is sharply down (~-20% - $) from its mid-April high but still in positive territory year-to-date, which is a fine performance in itself considering the rather difficult circumstances. It is worth noting that the industry still boasts excellent fundamentals and is generating unprecedented amounts of cash thanks to its vastly improved financial discipline.

The market has clearly priced this in judging by the surge in gold-mining stocks (+159% - $) relative to gold (+75% - $) since the start of 2016, corresponding to performance leverage of ~2x. However, one should bear in mind that gold-mining stocks still lag far behind their historical record levels reached in September 2011. Whereas gold prices are flat versus September 2011, gold-mining share prices are still almost 45% lower ($).

Yet market sentiment about the industry going forward has improved substantially in recent months, largely because of more upbeat expectations about future gold price trends; the price of gold is now expected to average $1,900/oz this year versus $1,716/oz estimated back in January.

12-month forward earnings prospects have turned upwards as a result. Although they are still ~11% lower than at the same time last year, they have recovered by more than 10% since bottoming out back in March.

Valuation of the gold-mining industry

In P/NAV terms, the gold-mining industry’s valuation does not at all reflect the current level of gold prices and instead remains close to its historical lows! At ~0.85x, the industry’s NAV multiple is one standard deviation below the average observed since July 2013 (~1.05x).

The fact is that the market is still not convinced that the mining industry is capable of generating any value. And yet everything now looks set for it to do so.

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