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In the Inflation/Reflation Debate, Gold Could Win

February 09, 2021

Read Time 6 MIN

 

Reflation Trade

Gold had a strong start to the year, moving to its monthly high of $1,959 per ounce on January 6 at the same time the U.S. dollar index (DXY)1 made fresh three-year lows. However, gold quickly reversed course as it became clear the democrats had won a runoff election in Georgia, which, with the help of a democratic vice president, gave them control of the Senate. With this crucial victory, the markets quickly embarked on a “reflation trade”, betting that the democrats would pass trillions of dollars of additional spending on pandemic relief, infrastructure and green initiatives. Interest rates spiked higher, taking ten-year treasuries to a ten-month high of 1.18% on January 12. The rise in rates bolstered the U.S. dollar, driving the DXY to its monthly high on January 18, while gold fell to its monthly low of $1,804.

We had thought such a victory for the democrats would be positive for gold because it might lead to more deficit spending, higher taxes and more regulations. However, the near-term rise in yields and the dollar overwhelmed the longer-term implications, at least for now. Gold trended higher in the second half of the month as rates and the dollar eased. Gold ended the month at $1847.65 for a $50.71 (2.7%) loss. The NYSE Arca Gold Miners Index2 (GDMNTR) fell 3.8%, and the MVIS Global Junior Gold Miners Index3 (MVGDXJTR) lost 7.0%.

Hi Ho Silver!

Gold also gained support at month-end when trading excitement broke out in silver. Reddit, a popular online community hosts the WallStreetBets forum, where retail investors and day traders exchange ideas. Early in the month, investors using Reddit targeted electronic game store GameStop Corp. and other relatively small companies with large short interest as buying opportunities. The retail buying and short covering by hedge funds drove GameStop to a 1,625% gain in January. On January 28, the Reddit traders turned their attention to silver, which they allege is being suppressed by banks to mask inflation. As of February first, over the past three trading days, silver has gained 15% to $29 per ounce, the Solactive Global Silver Miners Index4 gained 23%, and individual silver stocks have gained as much as 59%. Trading volumes and inflows to silver bullion exchange traded products have exploded higher.

Manipulation No Match For Fundamentals

It’s a big stretch for the Reddit traders to go from targeting a small stock with enormous short interest like GameStop to targeting the multi-billion dollar silver industry. It appears that their investment decisions focus on conspiracy theories, social justice and mob rule rather than commodity and industry fundamentals. Nonetheless, they represent a new type of investor to silver that may enable it to trade at higher levels. Silver has been in a bull market with gold, so we don’t see it in a short squeeze. In fact, net speculative positioning in silver futures has been long for over a year. The gold/silver ratio is currently at 68, which is near the ten-year average of 70. The ratio hit a low of 31 in 2011 when silver reached its all-time high of $49.80. Also, silver only reached $30 per ounce when gold was making new all-time highs last August. Therefore, higher silver prices here would be well within historic norms. However, many silver stocks are now trading at extraordinary multiples and may pull back once the Reddit frenzy has run its course.

Reddit/WallStreetBets is the first black swan phenomenon since the COVID crash. It is the unintended consequence of radical government policies that drove rates to zero, created trillions of dollars of free money and a society with copious free time. A free market system cannot achieve its function of price discovery and efficient capital allocation if it is subjected to manipulation, government mandates or mob rule. Free markets have been weakened by Reddit/WallStreetBets. In the current environment, the next black swan may bring more ominous damage to the financial system.

Reflation vs. Inflation

There has been a lot of talk in the press of inflation since the democrats have taken control of Washington. We find this misplaced, as there is a difference between reflation, which is stimulating the economy to get back to normal growth, and excessive inflation, which is a rise in wages and prices. The chart shows that inflation expectations have simply returned to normal levels of around two percent, where they have been for decades. The chart also shows how inflation expectations cratered with the deflationary shocks of the financial crisis in 2008 and the COVID crisis in 2020. In both crisis, inflation expectation rebounded to historic norms. Gold is not reacting to inflationary pressures because there is not yet any evidence of excessive inflation.

U.S. Market Inflation Expectations (5 Years Ahead)

U.S. Market Inflation Expectations (5 Years Ahead)

Source: Bloomberg. Data as of December 2020.

Inflation: Case For vs. Case Against

Here, we contrast the cases for and against inflation.

Case for inflation:

  • Shortage of manufacturing workers caused by new e-commerce jobs with higher wages
  • The end of cheap labor in China and Asia in general
  • The pandemic has reduced capacity in many industries
  • The pandemic has also reduced the pace of globalization and international trade
  • A savings glut and pent-up demand will bring a surge in post-pandemic spending
  • The Fed can never raise rates for fear of crashing the stock market and making debt service unbearable
  • The Fed has adjusted policies to enable inflation above its two percent target
  • It is hard to believe the shift to concerted fiscal/monetary stimulus on an unprecedented scale won’t bring an inflationary cycle
  • The last time we saw such stimulus in the U.S. was in response to the depression and WW ll, which brought an inflationary cycle in which the annual change in the CPI peaked at 19.7% in March of 1947

Case against inflation:

  • With the pandemic, spending has focused on goods, so future demand has been satiated
  • There is no pent-up demand in services, only a return to normal; you only need one haircut or you might take that cruise, but not five cruises
  • High levels of unemployed will act as an ongoing drag on wages
  • Accelerating technological change will keep the cost of goods in check
  • The U.S. Federal Reserve (Fed) has been trying to generate inflation for over a decade without success
  • Excessive debt and aging demographics will keep a lid on growth
  • Millions of households are behind on rent and mortgage payments
  • A savings glut reflects more conservative consumers traumatized by the pandemic that spend less
  • Negative rates, massive QE and fiscal stimulus have failed to prompt inflation in Japan for decades recently, Japan has been in deflation for three months

And The Winner Is...Gold

Weighing the pros and cons, we believe history provides the best guide. The Japan model makes a compelling case against inflation; however, the post-WWll model makes an inflationary cycle the most likely outcome, given the overwhelming stimulus efforts. This would be the most bullish for gold, although, a low growth, low inflation outcome presents abundant risks that could also drive gold for years. Such risks include debt problems, even more radical fiscal and monetary policies, worsening income disparity and social unrest.

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IMPORTANT DISCLOSURES

All company, sector, and sub-industry weightings as of January 31, 2020 unless otherwise noted. Source: VanEck, FactSet.

Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.

1The U.S. Dollar Index (DXY) measures the value of the U.S. dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. 2NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold. 3MVIS Global Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver. 4Solactive Global Silver Miners Index is a freefloat, market capitalization weighted index of international companies active in the exploration, mining and/or refining of silver.

Any indices listed are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in a Fund. Certain indices may take into account withholding taxes. An index’s performance is not illustrative of a Fund’s performance. Indices are not securities in which investments can be made.

NYSE Arca Gold Miners Index is a service mark of ICE Data Indices, LLC or its affiliates (“ICE Data”) and has been licensed for use by VanEck Vectors ETF Trust (the “Trust”) in connection with VanEck Vectors Gold Miners ETF (the “Fund”). Neither the Trust nor the Fund is sponsored, endorsed, sold or promoted by ICE Data. ICE Data makes no representations or warranties regarding the Trust or the Fund or the ability of the NYSE Arca Gold Miners Index to track general stock market performance.

ICE DATA MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND HEREBY EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE WITH RESPECT TO THE NYSE ARCA GOLD MINERS INDEX OR ANY DATA INCLUDED THEREIN. IN NO EVENT SHALL ICE DATA HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.

MVIS Global Junior Gold Miners Index (the “Index”) is the exclusive property of MarketVector Indexes GmbH (a wholly owned subsidiary of Van Eck Associates Corporation), which has contracted with Solactive AG to maintain and calculate the Index. Solactive AG uses its best efforts to ensure that the Index is calculated correctly. Irrespective of its obligations towards MarketVector Indexes GmbH, Solactive AG has no obligation to point out errors in the Index to third parties. The VanEck Vectors Junior Gold Miners ETF (the “Fund”) is not sponsored, endorsed, sold or promoted by MarketVector Indexes GmbH and MarketVector Indexes GmbH makes no representation regarding the advisability of investing in the Fund.

Please note that the information herein represents the opinion of the author, but not necessarily those of VanEck, and this opinion may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.

About VanEck International Investors Gold Fund: You can lose money by investing in the Fund. Any investment in the Fund should be part of an overall investment program, not a complete program. The Fund is subject to the risks associated with concentrating its assets in the gold industry, which can be significantly affected by international economic, monetary and political developments. The Fund’s overall portfolio may decline in value due to developments specific to the gold industry. The Fund’s investments in foreign securities involve risks related to adverse political and economic developments unique to a country or a region, currency fluctuations or controls, and the possibility of arbitrary action by foreign governments, or political, economic or social instability. The Fund is subject to risks associated with investments in Canadian issuers, commodities and commodity-linked derivatives, commodities and commodity-linked derivatives tax, gold-mining industry, derivatives, emerging market securities, foreign currency transactions, foreign securities, other investment companies, management, market, non-diversification, operational, regulatory, small- and medium-capitalization companies and subsidiary risks.

About VanEck Vectors® Gold Miners ETF (GDX®) and VanEck Vectors® Junior Gold Miners ETF (GDXJ®): An investment in the Funds may be subject to risks which include, among others, investing in gold and silver mining companies, Canadian issuers, foreign securities, foreign currency, depositary receipts, small- and medium-capitalization companies, equity securities, market, operational, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management risk, fund shares trading, premium/discount risk and liquidity of fund shares, non-diversified and concentration risks, all of which may adversely affect the Funds. Foreign investments are subject to risks, which include changes in economic and political conditions, foreign currency fluctuations, changes in foreign regulations, and changes in currency exchange rates which may negatively impact the Funds’ return. Small- and medium-capitalization companies may be subject to elevated risks. The Funds’ assets may be concentrated in a particular sector and may be subject to more risk than investments in a diverse group of sectors.

Diversification does not assure a profit or protect against loss.

Please call 800.826.2333 or visit vaneck.com for performance information current to the most recent month end and for a free prospectus and summary prospectus. An investor should consider a Fund’s investment objective, risks, charges and expenses carefully before investing. The prospectus and summary prospectus contain this as well as other information. Please read them carefully before investing.

©2021 VanEck

IMPORTANT DISCLOSURES

All company, sector, and sub-industry weightings as of January 31, 2020 unless otherwise noted. Source: VanEck, FactSet.

Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.

1The U.S. Dollar Index (DXY) measures the value of the U.S. dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. 2NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold. 3MVIS Global Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver. 4Solactive Global Silver Miners Index is a freefloat, market capitalization weighted index of international companies active in the exploration, mining and/or refining of silver.

Any indices listed are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in a Fund. Certain indices may take into account withholding taxes. An index’s performance is not illustrative of a Fund’s performance. Indices are not securities in which investments can be made.

NYSE Arca Gold Miners Index is a service mark of ICE Data Indices, LLC or its affiliates (“ICE Data”) and has been licensed for use by VanEck Vectors ETF Trust (the “Trust”) in connection with VanEck Vectors Gold Miners ETF (the “Fund”). Neither the Trust nor the Fund is sponsored, endorsed, sold or promoted by ICE Data. ICE Data makes no representations or warranties regarding the Trust or the Fund or the ability of the NYSE Arca Gold Miners Index to track general stock market performance.

ICE DATA MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND HEREBY EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE WITH RESPECT TO THE NYSE ARCA GOLD MINERS INDEX OR ANY DATA INCLUDED THEREIN. IN NO EVENT SHALL ICE DATA HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.

MVIS Global Junior Gold Miners Index (the “Index”) is the exclusive property of MarketVector Indexes GmbH (a wholly owned subsidiary of Van Eck Associates Corporation), which has contracted with Solactive AG to maintain and calculate the Index. Solactive AG uses its best efforts to ensure that the Index is calculated correctly. Irrespective of its obligations towards MarketVector Indexes GmbH, Solactive AG has no obligation to point out errors in the Index to third parties. The VanEck Vectors Junior Gold Miners ETF (the “Fund”) is not sponsored, endorsed, sold or promoted by MarketVector Indexes GmbH and MarketVector Indexes GmbH makes no representation regarding the advisability of investing in the Fund.

Please note that the information herein represents the opinion of the author, but not necessarily those of VanEck, and this opinion may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.

About VanEck International Investors Gold Fund: You can lose money by investing in the Fund. Any investment in the Fund should be part of an overall investment program, not a complete program. The Fund is subject to the risks associated with concentrating its assets in the gold industry, which can be significantly affected by international economic, monetary and political developments. The Fund’s overall portfolio may decline in value due to developments specific to the gold industry. The Fund’s investments in foreign securities involve risks related to adverse political and economic developments unique to a country or a region, currency fluctuations or controls, and the possibility of arbitrary action by foreign governments, or political, economic or social instability. The Fund is subject to risks associated with investments in Canadian issuers, commodities and commodity-linked derivatives, commodities and commodity-linked derivatives tax, gold-mining industry, derivatives, emerging market securities, foreign currency transactions, foreign securities, other investment companies, management, market, non-diversification, operational, regulatory, small- and medium-capitalization companies and subsidiary risks.

About VanEck Vectors® Gold Miners ETF (GDX®) and VanEck Vectors® Junior Gold Miners ETF (GDXJ®): An investment in the Funds may be subject to risks which include, among others, investing in gold and silver mining companies, Canadian issuers, foreign securities, foreign currency, depositary receipts, small- and medium-capitalization companies, equity securities, market, operational, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management risk, fund shares trading, premium/discount risk and liquidity of fund shares, non-diversified and concentration risks, all of which may adversely affect the Funds. Foreign investments are subject to risks, which include changes in economic and political conditions, foreign currency fluctuations, changes in foreign regulations, and changes in currency exchange rates which may negatively impact the Funds’ return. Small- and medium-capitalization companies may be subject to elevated risks. The Funds’ assets may be concentrated in a particular sector and may be subject to more risk than investments in a diverse group of sectors.

Diversification does not assure a profit or protect against loss.

Please call 800.826.2333 or visit vaneck.com for performance information current to the most recent month end and for a free prospectus and summary prospectus. An investor should consider a Fund’s investment objective, risks, charges and expenses carefully before investing. The prospectus and summary prospectus contain this as well as other information. Please read them carefully before investing.

©2021 VanEck