The Stock Market and Gold Are Both at Record Highs. Only One of Them Can Be Right.

As U.S. stocks approach valuations that haven’t been seen since just before the 2022 bear market, gold is simultaneously hitting record highs. This scenario presents a dilemma for investors, as both assets are signaling conflicting messages about the state of the economy—and only one can be correct.

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Gold, traditionally seen as a safe haven during economic or political turmoil, has surged in value. Christopher Mancini, co-manager of the Gabelli Gold Fund, attributes this rise to growing concerns about the U.S. Federal Reserve's ability to control inflation effectively. He points out that the increase in gold prices suggests skepticism about the Fed’s chances of engineering a "soft landing" for the U.S. economy. According to Mancini, gold's rise indicates one of three possibilities: the economy is heading for a recession, inflation will remain stubbornly high, or both.

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All three scenarios—recession, inflation, and especially stagflation—are negative for stocks. Stagflation, a combination of stagnant economic growth and high inflation, was a major issue during the 1970s and contributed to a prolonged slump in the stock market. Mancini believes that gold’s price reflects a strong likelihood that at least one of these undesirable outcomes could materialize, suggesting that investors are bracing for difficult economic conditions.

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Mancini’s insights carry weight, as his Gabelli Gold Fund has outperformed its Morningstar precious-metals fund category and its benchmark index over the past three years. Given the current situation, he believes that gold may continue to climb, and investors should consider adding gold to their portfolios as a hedge against potential stock market declines.

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Gold reached an all-time high of $2,685 an ounce in September, and experts believe it has further room to grow. There are three key reasons for this optimism. First, central banks worldwide are expected to keep buying gold. Although China’s central bank has paused its purchases recently, Shree Kargutkar, co-portfolio manager of the Sprott Gold Equity Fund, predicts that China will resume buying soon. As the world’s second-largest economy, it would be surprising if China didn’t significantly increase its central bank's gold holdings, Kargutkar argues. Other countries, including Russia, India, Poland, and Turkey, have also been active in increasing their gold reserves.

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Second, central banks are cutting interest rates, which tends to boost gold’s appeal. In addition to the U.S. Federal Reserve, central banks in countries like Canada, the U.K., and across Europe have been lowering interest rates. As rates decline, the opportunity cost of holding gold decreases, making it a more attractive investment. Kargutkar believes this trend will be a major tailwind for gold prices in the future.

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Third, retail demand for gold remains strong globally, particularly in India. The country recently reduced import taxes on gold, making it cheaper for consumers and spurring increased demand. As India steps in to fill the gap left by China’s temporary pause in buying, the global appetite for gold is expected to remain robust.

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The unpredictable factor, however, is whether gold’s ominous forecast for the U.S. economy proves correct. If the Federal Reserve fails to engineer a soft landing or if it becomes clear that one is unlikely, gold prices are likely to soar even higher, Mancini says. For investors seeking exposure to gold, Mancini recommends owning not just physical gold but also shares in gold mining companies, which offer an additional layer of potential profit.

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So far this year, the prices of both gold and gold stocks have risen by about the same percentage. But Mancini argues that gold mining stocks should be performing even better, given the favorable operating leverage enjoyed by gold companies. This leverage arises from the fact that the cost to mine gold has remained relatively constant, while the price of gold has surged.

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At the start of the year, it cost the average gold mining company about $1,400 to mine an ounce of gold, while the market price of gold was around $2,100. This gave gold miners a profit of $700 per ounce. With gold now near $2,800, profits have roughly doubled, yet the increase in mining companies’ stock prices hasn’t fully reflected this improved profitability. As a result, many gold mining companies are using their increased cash flow to buy back shares, pay down debt, and reward shareholders with dividends.

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Mancini highlights five gold mining companies that he believes are particularly well-positioned to benefit from rising gold prices. Among them is Kinross Gold, a Canadian firm developing the Great Bear mining asset, which is expected to generate high profit margins and substantial free cash flow. Another is Eldorado Gold, which operates mines in Turkey and Canada and is developing a large operation in Greece.

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Mancini also favors Northern Star Resources, an Australian firm with low geopolitical risk, and Endeavour Mining, which operates in West Africa. Despite facing risks like nationalization and political instability, Endeavour’s stock is attractively priced, offering a free cash flow yield of 25%. Lastly, he mentions Artemis Gold, a Canadian company developing the Blackwater Mine in British Columbia, which will be one of the world’s largest and lowest-cost mines.

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In conclusion, gold’s rise to all-time highs signals investor caution about the future of the U.S. economy. As stocks approach elevated valuations, the conflicting messages between the stock market and gold suggest that a turbulent period may lie ahead, making gold a valuable asset for risk-averse investors.

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