Even a cursory look at the commodity market reveals that the Fed's massive support for the pandemic-shocked economy has created its share of unexpected consequences. Gold is an obvious beneficiary of the exploding dollar supply but industrial metals like copper are now rallying as well.
As Global X notes in a recent research note, the factors supporting gold are relatively clear. The Fed's unprecedented balance sheet expansion has flooded the world with dollars, pushing USD down 10% against a basket of global currencies in the past five months and reviving the long-dormant conversation about inflation. Both are natural positives for gold as a purchasing power hedge against a weakening fiat currency.
With the dollar now at a two-year low, consumer inflation has yet to accelerate beyond its current faint pulse, but it remains a real challenge to retirees and other investors who need to secure positive real returns in order to preserve wealth, let alone build on what they have. Slack global demand for oil in particular continues to keep overall price pressure in check, but the Fed's money-printing activities have arguably pushed inflation into securities markets where asset valuations have swelled to accommodate the flood of easy money available. Those who are uncomfortable with this asset inflation naturally gravitate toward gold.
Although physical metal and the funds that hold it have been the biggest initial beneficiaries of this "Fed shock," we can see signs that interest rates will remain depressed (and inflation risk elevated) for the long term. Unless annualized inflation trends below 0.7% a year between now and 2030, 10-year Treasury bonds purchased today will pay a negative real rate to maturity, exposing investors to significant risk of locking in a long-term loss. This, in turn, extends the attraction of gold forward into the next decade and beyond, when today's newly permitted exploration projects will be up and running.
Global X provides exposure to this end of the mining industry via the Gold Explorers ETF (GOEX), which focuses on companies that have yet to fully define key projects and so might be years out from achieving their ultimate potential in terms of reserves and revenue. Thanks to that growth profile, the fund is outperforming senior miners as well as the physical metal . . . given what Global X describes as a "long and uncertain road to recovery," demand could remain elevated for years to come.
At a minimum, the firm suspects that the dollar is not going to recover before the end of 2020. This scenario feeds into perceived strength for silver and, surprisingly copper, ordinarily a beneficiary of a strong economic environment and rising interest rates. However, demand for copper in China has reportedly surged 20% year over year on the back of increased stimulus incentives there. As a result, global consumption may only decline 5% this year before rebounding as the COVID outbreak recedes.
Given production shortfalls in Chile, Peru and elsewhere, we could even see copper supply deficits despite relatively slack demand, in which case the Global X Copper Miners ETF (COPX) becomes extremely attractive. Fund holdings are trading at a 5% discount to book value as the industrial metals story remains misunderstood on Wall Street, but now that COPX is in positive territory YTD the window for buying the dip may be narrowing but not closing.
And when the global economy recovers, these miners will thrive. After all, the Fed can only print paper. The supply of metal remains beyond central bankers' control.
