What's driving the price of gold

0:09I'm very happy to welcome Axel Merk to Investing Experts, President and Chief Investment Officer at Merk Investments, over$4 billion that you're managing. It's really great to have you. I, for one, have known about you for quite some time. A long time ago, I used to edit your work that we used to republish on Seeking Alpha. So it's great to finally have you on the podcast. Thanks for making the time. Great to be with you. And that painful job of editing my writing is now done by AI bots and by compliance. Well, I learned a lot because I feel like when I was editing people's work that was coming from outside Seeking Alpha, that's part of what enables me to call Seeking Alpha, Seeking Alpha University.

0:51Because more than editing, I was really reading and just learning a lot about the market. So appreciate your work. So talk to our audience, for those that know you, those that don't know you, what are you focused on? What's your specific focus of the markets? Yes, well, as you mentioned in the introduction, we manage around$4 billion these days. In the precious metals space, both on the physical gold side and on the precious metals mining side, we weren't always there. The market kind of has pushed us into that. At the time you were editing my writings, we had a very substantial focus on currencies, everything from directional to sophisticated alpha strategies.

1:34After the Eurozone debt crisis, people didn't want to hear anything anymore about currencies. And one of the things about something fancy, as you might want to call it, currencies, is people are interested in those sort of things when the markets perform really poorly. but why do you invest in an alternative strategies when the markets quote-unquote always go up right and we had started investing in gold around 2004 already it's always been part of what we've done but it's gotten more prominent and these days it's it's exclusive in that direction and just to take another step back I first founded a company in 1994 actually abroad I took it to the U.S.

2:19in 2001. And if you want to go even further back, many people are not aware. I actually had a master's in computer science, although I never worked in the field. I mentioned that because the focus of that was artificial intelligence. And to take one step further back, in the 1980s, I studied public key cryptography, kind of the foundation of lots of the crypto stuff out there. but these days I hire quant-cent programmers to do things but what it means is I have opinion about all these things and to maybe round that out about the opinions part we tend to focus on macro things we do quantitative work as well but in my public speaking in particular it's on macro and we like to go to the sources so I have listened to just about every press conference of the European Central Bank since the early 2000s.

3:13There happened to be one this morning as we're recording this on June 11. And so similarly at the Federal Reserve, I engage policymakers. I have gotten to know Kevin Walsh personally, the new Fed share. That doesn't mean anything that what I'm saying is correct or not, but I tend to come from a slightly different perspective because it's truly a bottom-up building of my opinion. I want to get your take on gold and precious metals and miners because we've been talking a lot on this podcast and on the news podcast about how gold has not been behaving as it typically has in the past. There's a lot of confusion out there.

3:54The price of gold in the long run has a zero correlation to equities. However, that doesn't mean it's always uncorrelated. The correlation to risk assets is moving in and out. In the long run, I believe a good way to think about gold is it's ultimately it's this brick, this barbaric relic, right? It doesn't do anything. So it competes literally with the purchasing power of the currency in the long run. You can actually measure that. You can measure real interest rates in the market. And when I talk to gold bugs in particular, they say, what the hell? Nobody knows what long-term real interest rates are.

4:34But those are market measures. And when they move, asset prices move. And gold is particularly sensitive to that. Now, even the correlation to real interest rates, that's the TIPS yield, is not stable. And last year, there wasn't any correlation. But that correlation became quite firm with the beginning of the war in Iran. And the way I would like to characterize it is that the market has been treating the war in Iran as a shock in contrast to a structural change. And so what's been happening is that when the fear about the war in Iran is flaring up, bonds are selling off. But because it is a shock, inflation expectations aren't changing, which means real yields are moving higher.

5:27And that is part of the reason why the price of gold has been so sensitive and some people are scratching their head. My God, there's a crisis. Why isn't gold moving up? And it happens to correlate with what risk assets are doing, right? Because risk assets have a similar characteristic in that particular scenario. And so I'd like to just throw it out there as thought as people when they think about the price of gold. What would you say about the miners as they move along with the price of gold? What other context would you provide there? Well, first, I happen to invest in both gold and miners.

6:02Many investors just choose one or the other. Indeed, in the old days, the speculators used to go into gold. And then if they weren't really speculative, they go into miners. Within the mining space, by the way, the risk profile is quite different between the majors and junior companies. The junior companies are literally options that you strike gold and you can develop a mine that you have access to funding. There's some credit risk in there, indirectly at least. They probably raise money on the equity side, but that's factoring in there. Then suddenly meme stocks came about, digital assets came about, and the speculator was more interested in those aspects.

6:45SPACs were of interest and the like. As we're talking, the latest and greatest thing to invest in, and by the time this airs, I believe the IPO will have happened, SpaceX is going public. So there are more exciting things, so to me. And so what can happen periodically is that the volatility is dampened in these asset classes, but the speculator is not a loyal investor. And so when something moves, they come back. And a little over a year ago, the speculator came back to the gold sector. And then in the springtime, there was quite a bit of leverage in some of those positions. And guess what? When risk flares up, people delever.

7:23And so the headwinds to the price of gold were more significant. And so I think that framework, I think, is important. The miners more broadly, one of the things, and to maybe bridge that to the AI question, is let me give you a long answer here. In 2011, Mark Andreessen published a famous piece about software eating the world. And a key aspect of that was that the barrier to entry is low, profit margins are high. Fast forward to the world of AI, and AI is eating software. And so what's happening is you have this investment where a lot of investment apparently is necessary. The margins are somewhat uncertain.

8:05And the huge difference is that suddenly you have a level playing field with industrial investments, precious metals being a component of that, where the profit margins, at least in the current environment, are very high. And so that has attracted the interest, the much broader interest. One of the things we see is that in mid-sized mining companies, you see portfolio managers that are generalists participating. And if and when they allocate money, the moves can be quite significant. The one thing before I end it back to you I might want to add is exchange-traded funds are not particularly suitable to provide funding to mining companies.

8:44And it's a depleting asset. And especially the junior mining companies have to go to the markets all the time, which means they're somewhat neglected in an era where, quote-unquote, everybody is investing in ETFs, which to us means there are more opportunities. We try to find companies where you have potential sources of alpha that go beyond the margins that are created by an upward move in the price of gold. You took the segue out of my words. I was going to ask, is it an ETF thing for the most part for retail investors? And if you're talking about miners and trying to find alpha, what are the metrics that you're most focused on?

9:21So as I indicated, ETFs are not well suited for the mining industry. First of all, the mining industry has the greatest dispersion of risk of any S &P sector. And that's a very fancy way of saying that the returns are all over the place. Another way of saying it is active management matters. And of course, ETFs are not particularly suited for true active management. The other one is that in the mining sector, there are lots of mining companies go public very early. So they're quite illiquid. You can technically put them in an ETF. But if you want to make your market makers happy that try to move the price of the underlying net asset value to the market price, they need to have an arbitrage opportunity.

10:12and they can use proxies, but that's very cumbersome with illiquid securities. So it's not illegal, but the big market makers just don't have an interest in that. And so what it means is that the funding is really done by private equity firms. We manage a close-end fund where we can do it, but not by where the bulk of the money is these days. Much of the funding is provided by family offices that have previously been successful investors. And the one characteristic kind of from an investment process that we look for is kind of what's applicable in any sector where you do fundamental analysis, which is we're looking for good management teams.

10:59And that is at least as important as a good resource. Obviously, you need to have a good resource, but we've been in situations where we've provided funding to a management team that didn't have an asset yet. And the reason is that it's the same. We call it venture capital light, right? When you hear about Silicon Valley, they invest in the team more than the idea, and they're perfectly okay if that team is pivoting. Funding is often provided only for a year or two. And obviously, not all of these projects work out. That's why you invest in many of them. But if you do that, you can take advantage of what we call the institutionalizing these assets.

11:41As they grow, bigger investors are joining. Eventually, they're added to indices. And just as in the IPO of SpaceX, where Elon Musk has been very eager that it's added to indices right away, that's the progression usually in a company that goes public. Over time, it gets added to indices. And when it is embraced by larger types of investors, it tends to have an impact on the valuation. And so from an active management point of view, you can have a disproportionate impact on the portfolio because then you're not dependent on the price of gold, quote-unquote, always going higher. What would you say about the ETFs like GLD, for instance, about the price of gold?

12:21What you see is what you get, right? They invest in the largest ones, but they have company-specific issues. They have recently worked through some of them. but they are because they're so large they are too large to to replenish the gold that they're mining fast enough and that even the the smaller companies are not large enough to just gobble them up to to buy them and so some of them have started to move from the from the more traditional gold mining to more copper gold mining like when you mine you there's usually one more than one thing, one mineral in the ground. We invested in a gold company.

13:06They discovered lithium, a market like lithium, so they rebranded themselves as a lithium company. But what happens on these large miners, they tend to then embrace copper gold projects that are much more capital intensive, which suits them because they're obviously large enough for that. But these are 20-year projects, sometimes in jurisdictions where you don't know whether you have the security after 20 years, whereas on the more traditional side, these smaller projects are very more kind of, it's more compact. The clarity is more there. That doesn't mean one investment is better than the other, but it makes them different, right?

13:48It makes it, provides a different profile. There happen to have been some corporate issues in some of the largest mining companies as well. And they matter, right? because they influence how that sector moves. But a side effect of that is that if you look at, there are still a lot of mutual funds in that space, and the returns are quite widely spread depending on where the emphasis is. And that's, I mean, that's the beauty of active management. You truly get that in that space. Are you also looking at other precious metals? Like you mentioned, the copper bleeding into gold. Are you looking at other precious metals?

14:28Are you looking? Well, silver is the most obvious one. The challenge on the silver side is that there are not many good pure silver companies. And silver tends to be a byproduct. The price of silver is notoriously volatile. Just for reference, the price of gold historically, and I haven't looked at recent months where volatility has gone up, but historically is similar to that of the equity markets and then has these episodes where it spikes higher. Well, silver has always been notoriously more volatile. We happen to invest in one of the largest private silver companies. We can, in a close-end fund, invest in a private company as well.

15:07And so we can provide access to certain things. But it's really gold and silver, the emphasis is. Gold, because it's less volatile, the visibility is a little bit less. Also, in the silver companies, you tend to attract more speculators and nothing wrong with speculators, but it does add to the volatility profile and we tend to be long-term investors. And so that our investment approach, yes, we have silver exposure, but overall we focus on precious metals more broadly. Wherever there is an opportunity, of course, but it tends to be very heavy emphasis on the gold side of things. And what do you see for the next, let's say, year?

15:54Like, let's say near term and long term, how are you thinking about gold right now? Sure. Tomorrow, the price of gold is going to be there. And then in a week, it's going to be at this level. I think I'd say part of the reason I gave this explainer as to what is driving the price of gold in the current environment is because I think it's the price of gold is hostage to what's happening in Iran. And as we were speaking, right, the mood was swinging and there were some very substantial moves in the metal and in the miners as a result of that. Ultimately, the market gets used to just about any crisis.

16:29It's one reason why I don't like it when the perception actually comes to reality that the price of gold goes up because there's a crisis somewhere. We'll figure things out. I mean, even with Iran, the market will figure this out. it may not be good for long-term geopolitics it may not be good for this or that but let's take a bad case scenario where where iran does control the strait of amuse charges a toll of a dollar to a barrel a million or two million a ship that's a dollar to a barrel much of it would be absorbed locally by the producers because the price is set on a global stage and so the geopolitical implications obviously could be much broader, but the market will figure this out.

17:12Or shipping things by truck, obviously you can't ship that volume by truck, but the folks believing in getting out of fossil fuels should be happy because it encourages you to invest more in solar and nuclear energy. So we will, and on the fertilizer things, part of the reason the fertilizer is produced there is because energy is so cheap down there. It doesn't mean you can't produce fertilizer elsewhere, and it is created elsewhere as well. And so if you ask me for kind of the medium term, we obviously have a midterm election coming up. Odds are larger, higher, that we're going to get some sort of gridlock.

17:49On the one hand, that's good news because when you don't get anything done, you don't have much spending, except the only way to get things done is if you promise everybody something and then you end up not having entitlement reform, which is kind of a key driver for many investors to invest in something like gold because they're worried about the purchasing power of the dollar. Another angle, tariffs do matter for disaster class. I believe that while people focus on the flow of goods, the flow of currency is the other side of that coin, no pun intended. When you have tariffs, you have less money, less currency flowing into the U.S.

18:29that helps fund U.S. deficits, which translates to higher yields. And then I briefly mentioned Kevin Walsh earlier. Unlike what some people might say, he is no dove. He said during the nomination hearing that more work needs to be done. Inflation is too high. I don't think he has much of an impact on rates in the short term, but it will depend a great deal of the sort of flexibility the market gives him. If we continue to have supply shocks and other shocks, the market will be in a driver's seat as to where rates are going to be. But a lot of people invest in gold as a diversifier and I do think it continues to fulfill that role.

19:15But as you pointed out in the beginning, in the short term, it's been correlated with equities. And so when that happens for a little bit, then people may take a little bit before they embrace gold again as a diversifier. Although I must say, when I look at the markets, I've seen speculators pair back their positions. Long-term investors, I have not seen a pair back positions in any meaningful amount. And I say that based on the kind of the visibility that we have from where we are. And so in some ways, as volatile as these times are, it's somewhat business as usual for the sector. Are you still looking at currencies these days?

19:56Well, I look at them. I get calls from journalists that have me taken off their Rolodex and want my latest wisdom of what happens to the Mexican peso and what do you like? I mean, obviously, what I learned there still applies. I don't trade currencies institutionally anymore. Kind of the one thing I can maybe that might be value to some people is, first of all, a lot of people are confused that if inflation goes up, why currency sometimes on that day actually moves higher. The reason is because the market believes the central bank will do the right thing and will have tighter policy. It's only then in the medium term when people realize, oh, my God, they didn't high grades.

20:34Maybe that currency needs to be weaker. The other thing is that currencies that have a significant current account deficit, in my analysis, are far more sensitive to economic growth. So when New Zealand or Australia had weak growth, the currency weakens and vice versa, whereas the eurozone doesn't really have that. And so the eurozone dynamics are very different from that of other currencies. And I love it when people comment on currencies that have no clue about them and the people say, oh, my God, they must be right. And it's a very interesting sector of the market that's as frustrating to trade as just about any other sector of the market.

21:20And one of the things I think when you talk to people, always make sure you differentiate between whether they are just a talker or whether they actually have money at risk in that space. Because it does make a difference often what they say and your choice as to who you listen to. It's funny. I was just talking to somebody today or yesterday, David Keller, and he was saying that he does not consider himself an expert trader or investor. He feels like his skill set is in educating, but he does feel like he has expert. So there is this a certain distinction between even if you don't have money or skin in the game that you can still give, you know, cogent analysis.

22:01Well, of course. And first of all, if you have enough gray hair, you probably have gotten some humility in the markets because you have been around a little bit. And also, I would say none of us, I certainly, do not have a crystal ball. The one thing I can do and any educator can do is we can get anyone out of their comfort zone and consider a different point of view. and then you as an investor can stress test your point of view against that. I wouldn't recommend anybody do any trade based on what I say or anybody else says, but if the argument is rational, if the person has credibility, well, why are they saying something I might disagree with?

22:49And that's where the value is, I think, in a discussion like this. yeah I don't know what the price of gold is going to be tomorrow but I have a process and I'll continue following that process what is your daily and weekly process like what are the things that you're looking at to inform you well I'm a I'm a cat herder in chief I'm the boss of my job and so I'm running a lot of meetings we have daily morning briefings we have risk meetings we have research meetings we one of the things we do is in the spring of 2008 I called Bill Poole Those old enough may recall that he's the former president of the St.

23:27Louis Federal Reserve. He was a big critic of Fannie and Freddie before they were taking on to conservatorship. And we talked to him to assess the macro picture. He is a kind of an open, he knows everything about any FOMC meeting that has ever taken place. But then at the other end of the spectrum, right, I'm a chief investment officer. and so I have to supervise our portfolio managers. They are the experts on the mining side. I kind of have a veto right and at the same time, we live in a regulated industry, so a lot of my time is spent that we cross the T's on many things

24:12and so we have a lot of internal discussions. One of the reasons I'm active on social media is because on social media, I get unfiltered feedback. If somebody disagrees with me, it's not that, hey, I'm the boss, and therefore they have to agree with me. And so it helps to get another perspective. I try to get out of my echo chamber. I think that's increasingly difficult. And so one of the things, we spend over$100 ,000 a year in getting news. I mean, it's just incredible. And a lot of that is Bloomberg, I suppose, because Bloomberg terminals are expensive. But it's, of course, you can get news from many sources.

24:56But being able to curate one's news is ever more difficult. And we have, long before the world was as polarized as today, worked very, very hard to try to get news from various sources and from everywhere, right? I mean, we are global investors in many ways. So our morning briefings do include global news. I listen to international news every day. And it's just trying to keep up to speed with what's happening out there. And in terms of being in discussion with your portfolio managers, is that process something that you talk about ahead of time and then you kind of let them do their thing. How is that set?

25:39Portfolio managers by nature are alpha personalities. Not all of them, but many of them. And you're sitting alpha, so you probably know something about it. And so they are independently driven. They know what they're doing. And so it ends up being a cat-herding exercise, at least as much as anything else. In our segment of the market, where we We invest in a lot of junior mining companies. There's a lot of talk to executives of mining companies and a lot of discussions of brokerage firms. They tend to be a link that provide introductions and the like. And so it's probably a little different from many investors these days that tend to more buy with the push of a button based on some quant algorithm.

26:26Do you guys use charts? Do you base a lot of things on charts? In none of our public communications do we use technical analysis. I phrase it this way. I did a lot of technical analysis in the 90s. Indeed, I applied AI to the market. For those of you old enough, you may remember there was a magazine, I think it was called Technical Analysis of Stocks and Commodities, it was a stock and commodities publication, and I calculated the fractal dimension of the stock market and kind of had written a paper and created a consumer version as to why if you apply technical analysis, it applies to both tick data and long-term data because the quote-unquote fractal dimension of short-term and long-term data is similar.

27:19And the article was never published because I was too academic in it. But I do. I used to say that technical analysis is important, especially when overtaking, to make sure that you see everything else is okay in the market. As a practical matter, most of what we do is based on fundamental analysis. But yes, we do monitor fundamentals and technicals. And specifically, I think, I realize a lot of listeners are more on the technical side. In the gold sector, it probably applies more than in other sectors, in part because there are so few fundamentals. Gold is so simple. And so it tends to attract the technical investor and that can become a self-fulfilling prophecy.

28:06You mentioned some connections with the Fed. If you were in Kevin Warsh's position, how would you be running things? What would you do either differently or what do you agree with that's being done? Well, he hasn't done much. Not much I can do differently at this stage. What he is faced with is first a market that has clearly dictated where interest rates are likely to be in the short term to the next several months. So that's probably not the most important thing right now. You have an FOMC that's very polarized right now. And one of the things I don't think that hasn't gotten enough coverage is Chris Waller.