Miners index (HUI) to gold regression impaired.

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For a regression relationship to hold, residuals need to frequently alternate between positive (miners stronger than the metal) and negative (miners weaker). If that latter tendency gets the upper hand, adding new data deteriorates the linear correlation. ‘Mending’ the regression is no longer a good idea. In order to obtain a minimal least squares distance, residuals now are mostly positive in the early years of the regression, whereas largely negative values cannot be avoided over much of 2021-22.

Discussion: hawkish FED and mining cost inflation

As often (nearly always) is the case, the FED has been late to react on the rise of inflation. The ‘transitory inflation’ myth lost its credibility since last year. ‘Supply chain issues’ were then invoked to justify prolonged inflationary pressures. Quantitative easing was scaled back more rapidly than planned and a first 25 bp rate hike followed in March.

One more recurring policy is ‘FED-speak’. The FED is very vocal on its intention to continue raising interest rates, possibly with 50 bp increments. Whereas they cannot alter supply constraints, aggravated by the Ukraine war, raising interest rates may impact demand, both directly (more expensive credit) as indirectly (sliding stock and bond markets reduce financial wealth).

If high inflation proves more sticky than anticipated, precious metals may uphold better. If the FED succeeds in calming down the price surge, long term inflation expectations may remain moderate. In this case expectations for the real interest rate would no longer be negative. That would be a severe headwind for precious metals.

Mining cost inflation is what makes miners more vulnerable now. Open pit miners need lots of fuel to operate their monster trucks. Milling of high volumes of low grade ore is also energy intensive. Underground miners need more steel to maintain their network of shafts and galleries. Mining ore requires a lot of electricity. Add rising labor costs and higher investment budgets to sustain mine production and you get a more complete picture.

A weaker gold price in itself does not necessarily push miners deeper below their regression line. The regression relationship already has the dominant factors on-board.  However inflation has an upward effect on the break-even value of gold-mining. The linear regression feels the effect on the intercept value, which most likely is creeping up.