What Metals Prices Can Tell Us About the Economy

Mining investors are often lumped into one of two camps. First are investors that seek to capitalize on cyclical stories, such as for base metals whose prices generally respond to increasing demand because of accelerating economic growth. Second are precious metals investors that tend to invest in gold or silver as a store of value or hedge against inflation. For these investors, monetary and fiscal policies, along with relative currency values, are important. Perhaps more so than silver, gold is often a safety play in times of uncertainty. Silver straddles both spheres since it is prized for its industrial properties but is also considered an alternative to gold for precious metals investors on a smaller budget since it generally follows upward moves in the gold price.

Base Metals Take the Lead in 2021

In 2020, precious metals prices performed their role as a haven when the global pandemic upended markets and severely crimped economic growth. While silver and gold have retained much of their gains, base metals appear to have taken the lead in 2021 as markets recover and economic growth accelerates. While silver and gold futures prices are down 11.3% and 4.5% year-to-date, respectively, copper, lead, and zinc futures prices are up 16.2%, 5.6%, and 1.9%, respectively. With metals production impacted by COVID-related work restrictions in 2020, supply and demand fundamentals appear supportive of prices. Secular themes, including trends toward electrification, favor metals used in electric vehicle batteries, charging stations, and solar and renewable power technologies. These include copper, nickel, and silver, among others.

Gold as a Hedge Against Inflation and Black Swans

While precious metals, notably gold, worked as a flight to safety play in 2020, gold prices have yet to signal deep concern about inflation despite record monetary and fiscal stimulus. In early March, the U.S. Senate passed a $1.9 trillion relief package, with the U.S. House of Representatives expected to vote on the bill this week. For its part, the Federal Reserve remains committed to accommodative monetary policies as it seeks to achieve its goals with respect to price stability (inflation) and employment.

The Federal Reserve has already indicated a desire for inflation to average 2% and a willingness to go above to meet the target. As a result, bond yields have risen, with the 10-year Treasury yielding 1.6% versus 0.92% at the end of 2020. This is likely a function of economic and growth expectations. So far, the Fed seems unconcerned about the prospect of runaway inflation, and Treasury Secretary Janet Yellen, formerly Chair of the Federal Reserve, noted that inflation was not increasing prior to the pandemic when the unemployment rate was a low 3.5%. She said policymakers will be monitoring the situation closely and will be prepared to act if inflation becomes a problem.

Another headwind for gold has been a strong U.S. dollar. Despite falling 6.7% in 2020, the U.S. Dollar Index has risen 2.63% since the end of 2020 to finish at 92.31 on March 8. Given that countries around the globe are pursuing similar monetary and fiscal policies, the dollar is likely to remain strong relative to other currencies.

Conclusion

Taking these facts into consideration, investors could consider adding base metals mining stocks to their portfolios as a way to benefit from growing demand as global economic growth accelerates.  And for exposure to greater infrastructure spending and secular trends, changes which bode well for metals linked to the theme of electrification.

With respect to gold, the near-term outlook is a little less certain, with perhaps greater volatility on the horizon as speculative interest dissipates. While the Federal Reserve likely has the tools necessary to combat a sharp rise in inflation, interest rates are likely to remain relatively lower for longer, and gold’s value could be supported as investors seek it as a store of value. Because both inflation and nominal yields are expected to rise moderately in 2021, investors should pay more attention to real yields (nominal yield less inflation), which could in some cases be negative. Lastly, allocations to precious metals and associated equities make sense as a precaution against unexpected events that could materialize, including misjudgment by the Fed, a broad sell-off of equities, or any other events that increase uncertainty and angst among investors.

Additionally, metals prices are up when compared with year-end 2019, and mining companies should be profitable at these levels. Moreover, high-quality reserves in favorable mining jurisdictions are becoming increasingly scarce, and merger and acquisition activity could accelerate as larger producers seek to replenish and grow resources and reserves by acquiring juniors. Therefore, investors could benefit by allocating capital to both producers and junior exploration companies.     

Suggested Reading:

Sources:

House Set to Take Up $1.9 Trillion Stimulus, Putting Biden on Track to Sign This Week, The Washington Post, Tony Room and Jeff Stein, March 8, 2021.

Yellen Plays Down Inflation Fears, Associated Press, U.S. News & World Report, Martin Crutsinger, March 8, 2021.

Hedge Funds Continue to Unload Their Bullish Gold Bets as Fed Remains Indifferent to Rising Bond Yields, KITCO, Neils Christensen, March 8, 2021.

Relentless U.S. Dollar Rally Continues as Yields Top 1.6%, FXSTREET, Kathy Lien, March 8, 2021.

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