Don’t Get Caught Up in the Hype of Gold Stocks

The big inflationary wave isn't here yet, so hold off on buying gold stocks

Gold has taken investors on a wild ride so far in 2020. From less than $1,500 per ounce in December, the price of the yellow metal soared to $1,700 by March. During the stock market crash, however, gold sank back to less than $1,500. But by April, gold futures spiked up to nearly $1,800 per ounce. But gold stocks have been about five times as volatile.

The VanEck Vectors Gold Miners ETF (NYSEARCA:GDX) is up 74% over the past year and has more than doubled since its lows in March. The gold miners have been on a crazy run.

Right now, the gold mining industry is on cloud nine. The sector appears to be enjoying ideal conditions. Gold has reached its highest price in ages, while miners’ input costs have hit rock bottom. As a result, miners’ profit margins are expanding, and their earnings are increasing at a similar pace. It seems like everything is going as well as possible for gold stocks.

Propelled by the novel coronavirus, macroeconomic trends are boosting gold. With all the Federal Reserve monetary stimulus and the deficit spending by the federal government, some analysts are predicting a huge wave of inflation.

In theory, all that spending and money printing is going to lead to a big decline in the value of the U.S. dollar. That, in turn, is going to create a huge boom for gold and mining stocks, according to the theory.

The Inflation Surge Will Be Limited And Temporary

There’s a difference between a short-term inflation spike in one part of the economy and an overall surge. Right now, the prices of certain things, such as various food products, are soaring.

That makes sense. Take eggs, for example. With some Americans in quarantine, they are cooking breakfast for themselves more frequently, causing demand for eggs to rise. But the supply of chickens has not risen, so there has been an egg shortage. Egg prices have jumped so much that consumers may file lawsuits for alleged price gouging.

But if you want to profit from a food shortage, buy an egg producer like Cal-Maine Foods (NASDAQ:CALM) or a meat processor such as Tyson Foods (NYSE:TSN). Gold stocks simply aren’t the right vehicle for a bet on agricultural commodity prices.

Excluding food, inflation is actually tanking. Consumer prices just  declined by the largest amount in a single month  since 2008. The prices of gasoline, airline tickets, and consumer services, among other things, have utterly tanked.

And that makes sense. With some people stuck at home, demand for a wide array of products has virtually disappeared. People may be buying more grocery staples, cleaning supplies, and home recreational equipment, but that hardly offsets the vast drop of demand and the prices of other products.

So far, the Fed’s efforts are merely preventing the deflation that would otherwise occur during a massive economic bust. If the government wasn’t pushing lots of money into the economy, we’d be at risk of entering a 1930s-style downward spiral of demand and consumer prices. And, as we’ve seen in both Japan since the 1990s and Europe since 2008, providing more cash does little to spark inflation, GDP growth, or economic activity if consumer demand is weak.

If the Fed keeps stimulating the economy after demand picks up, then inflationary conditions would drive a large surge of gold prices. But we’re far from that reality now.

Gold Stocks Won’t Protect Investors From a Crash

Another issue with buying mining companies’ stocks is that they are equities. And during stock market crashes, most equities tend to go down. Even defensive stocks, like consumer staples and utilities, got whacked during the stock market’s huge decline. And gold miners weren’t spared at all.

The VanEck gold mining ETF sent investors on a harrowing ride, with shares crashing from $30 to a low of just $16 between February and March. Of course, miners made back all those gains and more when the stock market recovered. But during the actual decline, miners fared even worse than the S&P 500.

In 2008, gold stocks also performed terribly during the market’s tumble. In that year, the ETF dropped from a high of $50 to a low of $17, representing a two-thirds decline. The shares recovered all their losses by November 2009, but the ETF failed to hedge against the market’s decline. In 2009, gold stocks only really rallied once the crisis had passed and people focused on the next anticipated inflationary boom.

The Verdict on Gold Stocks

As the recent gyrations of gold miners’ stocks have shown, there’s definitely a time and place for trading the shares. They have absolutely incredible volatility, which creates profitable opportunities. And miners’ profit margins are indeed climbing.

At this point, however, that’s all priced into the VanEck ETF and many individual mining companies stocks such as Newmont Mining (NYSE:NEM). This is a great time for investors to do some research and put a few gold stock names on their watchlists.

But  these stocks will be a lot cheaper following the next decline of the stock  market. Gold miners simply don’t work well during downturns because during market slumps, people stop caring about inflation for the time being.

If and when the euphoria about the reopening of the economy turns into worries about persistent unemployment and falling economic activity, gold prices will likely drop again. That will be a good time to buy gold stocks.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.