Monetary Policy's Impact on Gold Miners

Since the start of 2016, the dollar value of bonds trading at negative interest rates has come close to doubling around the world. As of mid-July, there are approximately $11 trillion of government bonds and more than $500 million of corporate bonds trading at less than zero interest rates, according to Fitch Ratings and Bloomberg.

During the same time frame the price of gold has gone up by 28 percent. Is there some sort of correlation here?

We are still mired in a world of slow growth. U.S. gross domestic product increased at an annual rate of 1.2 percent in July, much less than was expected. The eurozone economy has expanded at the same 1.2 percent annual rate in the second quarter, and Japan has essentially had zero growth for the first two quarters of 2016. Due to the slow growth, central banks will continue their aggressive policies of monetary easing, which can be seen in the expansion of negative interest rates. Their efforts effectively are to devalue currencies, which should bode well for gold.

We have not seen the end of printing money to stimulate growth, and it is apparent that the process has not worked yet and investor confidence is eroding.

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Consider, large European and Japanese banks and insurance companies are already facing growing costs and shrinking profits due to negative interest rates (that essentially charge banks to deposit funds with the central bank). Banks and insurance companies are also required to hold a certain percentage of their capital in safe, liquid assets. Government bonds are deemed to fill the safe and liquid criteria. Since the European and Japanese central banks have orchestrated negative rates on government bonds, each time one is purchased, the buyer loses money. This is one of the reasons bank stock prices around the world have declined.

It appears Japan may be preparing to take things even further. Japan's prime minister, Shinzo Abe, has been desperate to create inflation, hoping to stimulate growth. All the stimulus he and the Bank of Japan have orchestrated over the years has failed to create growth or inflation. After the election, he announced that he intends to accelerate his programs and has met with former Federal Reserve Chairman Ben Bernanke to discuss how further quantitative measures can be used.

In addition, printing of money in Europe will continue -- the European Central Bank confirmed that the monthly asset purchases of 80 billion euros ($89.5 billion) will run until the end of March 2017, or beyond, if necessary.

The impact on gold. Central banks trying to stimulate economic growth by creating money out of thin air generates a natural demand for gold as a hedge to currency devaluation. The recent trend of increasing gold prices will likely continue. Gold miners obviously benefit from higher gold prices because their profits improve as the price of gold increases. Gold miners' stock prices will increase at a faster rate than the price of the metal due to the leverage gained through the miners expanding profit margins.

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Gold prices peaked in September 2011 at more than $1,900 per ounce. Since then, miners have been in a bear market and have had to cut their operating costs to deal with the reality of gold that was trading below $1,100 per ounce at times. The survivors have been successful in doing so. In gold bull markets, gold miners typically outperform the metal as a 10 percent increase in gold prices can lead to a 30 to 40 percent increase in earnings for gold-producing companies. Many gold companies that have aggressively cut costs over the last five years are better positioned to grow their dividends as gold prices resume their upward trajectory.

Finally, well-run gold companies have historically traded in line with the Standard & Poor's 500 index on a price-to-book basis, but currently trade at a 30 percent discount. Hence an investment in gold miners offers three sources of returns: leverage to gold prices, potential for dividend growth and growth in valuation.

One way to invest in this trend would be to consider a gold miners exchange-traded fund, such as VanEck Vectors Gold Miners (ticker: GDX). With the fund, you gain diversified exposure to the sector at a low fund expense rate. An actively managed fund to consider is the Gabelli Gold Fund (GOLDX). It is the No. 1 ranked gold mutual fund over the last three and five years, according to Morningstar. The portfolio manager focuses on well-run gold companies that are growing production and replacing reserves without borrowing too much money.

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A point of caution: investing in gold miners is usually very volatile. You should consider adding up to 10 percent of gold in some manner into your portfolio to act as a hedge against the unprecedented monetary actions being taken around the world.

Disclosure: Phillips and clients of the firm own positions in GOLDX.