-
‘Gold ‘n guns’ proxy sees gold at $2,480 by year-end – Nicky Shiels
Fri Aug 09 2024
The combination of escalating global conflicts and increasing economic uncertainty has brought the investing concept of “Gold n Guns” front-of-mind for many investors, and according to one analyst, it can serve as a good proxy for how gold will perform in the months ahead.
“‘Gold n Guns’ gets a bad ‘tin-foil-hat-like’ rep, which is unfair,” said Nicky Shiels, Head of Research and Metals Strategy at MKS PAMP. “We consistently talk about escalating geopolitical [and] political developments in which the market was not short of war headlines the last 2.5 years, since Russia's invasion in Feb 2022. That changed a lot about Gold.”
Shiels noted that in the wake of Russia’s invasion, gold's historic and long-term correlation with U.S. Treasury yields broke down as the yellow metal “morphed into a truer geopolitical hedge (evidenced through a ramp-up in [central bank] purchases).”
“The invasion marked what is clearly a new war-time era we are living in,” she said. “And in war economies, defense stocks (just look at LMT stock price) surge as defense spending rises and gun sales surge as consumer fears [and] insecurities ramp up.”
As shown in panel 1 of the following chart highlighting U.S. consumer gun sales vs. gold, gun sales have “a strong +0.81 yearly correlation since 2002, and +0.79 quarterly,” Shiels said. “Panel 2 shows Gold vs the relative outperformance of the DJ Aerospace and Defense sector vs the Dow Jones (longer-term quarterly correlation since 2004) correlation is only +0.37, but notably the Gold:Defense correlations strengthen after Russian Invasion (to +0.66) and after the Hamas Oct 7th attack (to +0.83).”
She also cited a Bloomberg article that summarized the earnings for Rheinmetall, a large German tank and ammunition manufacturer, noting that the firm’s CEO, Armin Papperger, said the arms boom is the biggest he’s ever seen. “We have never seen such growth. The {defense} super cycle is clearly accelerating,” he said.
Shiels noted that the company expects “annual revenue growth of €2bn for some time, and sees revenue rising to around €10bn.”
“Total global military expenditure topped $2.44 TN in 2023 (up ~7% from 2022, the steepest YoY increase since 2009, driven by the big spenders, the U.S., China and Russia),” she said. “U.S. military spending alone was $916bn and representing 68% of total NATO military spending, with European [NATO] members upping their spend, but some falling short of the target spend of 2% of GDP formally committed to a decade ago.”
“Two years of war has fundamentally changed the European landscape and security outlook with a growing share of GDP being redirected (that is key here, redirected from infrastructure spend, ESG/Green initiative policies, etc) towards military spending,” Shiels said. “That NATO 2% is now being viewed as a base (read bottom in military spend and thus bottom in Gold price) rather than a threshold to reach.”
She also highlighted the rapidly rising debt in the U.S., which has resulted in the interest payments on the Federal debt surpassing annual defense spending.
“Given [the] proposed policies by both Harris and Trump, this is likely the start of a trend,” she said. Panel 2 on the above chart “shows US Interest payments > annual defense spending vs Gold price.”
“Similar to Europe, but the reverse, if no solutions are implemented, other components of the fiscal spend (military spend) may soon be constrained by the escalating cost of debt,” Shiels said. “That’s one of the core bearish rationales for the US$; when a country spends more servicing itself, vs protecting itself the value of its currency should decline (which obviously is indirectly bullish Gold/commodities).”
For these reasons, Shiels said, “‘Gold ‘n Guns’ is just short for gold in a geopolitical hedge in corporate speak.”
“The associated metrics – from defense/military spending to gun sales, defense stocks prices, [central bank] purchases, etc. – are one of the best proxies to quantify the ‘hard-to-quantify’ geopolitical premium and bid in Gold,” she said. “Perhaps CTA modeling should water down the age-old metrics (such as US real yields and US$) for more appropriate war-time era proxies like these metrics given the recently strong relationships.”
Shiels highlighted these facts to help address “the frustration around gold's short-term trading response (myself included), in that prices didn't reset strongly higher on this recent recession-led equity meltdown.”
“Gold is +17% YTD and has outperformed US equities (+10%) + Big Tech (+7% YTD). It's doing what it should be doing on a longer-term basis,” she concluded. “Gold will put in bull market gains in 2024 – it's only ‘right’ given the political [and] geopolitical turmoil/developments this year and the associated current [and] projected defense/gun (take your pick) spending. That implies another stab through double top ATHs around $2480 by yearend.”
Source: https://kitco.com/