Gold’s Bull Market Has Just Begun.
Target: $2,200 – within 18 Months
This is an edited version of the article “Gold: The Fog of War” by John R. Ing President and CEO, Maison Placements Canada Inc. The full version can be found at The Bull & Bear Financial Report, www.TheBullandBear.com.
The US is no longer the center of the world and their consumption-based economy is laboring under the weight of the higher tariffs. Nearly every policy is seen through a tariff prism. All of this is hurting economic growth and investment. Falling bond yields are signaling a growth slowdown and an inverted yield curve is a prelude to a recession. America is simply imploding, not dissimilar to Great Britain after the Second World War. President Donald Trump has sown the seeds of the dollar’s demise.
China’s Nuclear Option
Investors fear that China’s nuclear option of dumping their $1.1 trillion worth of US Treasuries will cause an increase in rates and plunge America into a fiscal crisis. China has been gradually reducing its Treasury exposure. Investors are misguided, not in the dumping of debt, nor in the increase in rates but that China’s real nuclear option is to weaponize the renminbi’s exchange rate and let the renminbi slide which would spark a competitive currency war.
To be sure, a Chinese devaluation would lessen the tariff blows by making their exports more attractive. But devaluation is not a zero sum game since every other exporting country would be compelled to follow suit and devalue their currency to maintain exports in a race to the bottom. Devaluations would also lead to an outflow of foreign money seeking a safehaven.
Currently, the US dollar enjoys a period of strength as a safehaven among the tariff wars. However, there are growing concerns that the dollar is a crowded trade. The implications are far reaching. The global monetary edifice is founded on a strong US dollar that has led to lower inflation, strong US exports and manufacturing.
What would happen if that came to an end? A currency cold war could change that. The fight with China started with trade deficits but could end with China moving its free floating currency lower. The US would have to follow as would the world’s other currencies in rounds of competitive devaluations, reminiscent of the Great Depression.
In The Beginning, There Was Gold
Also in the Thirties, the gold standard broke down as countries engaged in rounds and rounds of competitive devaluations.
Subsequently in the 1940s the Bretton Woods system established a new multi-lateral international monetary system with rules, the World Bank, and procedures to regulate commercial and financial relations among 44 countries. The US dollar was tied to gold, becoming the benchmark for which other currencies fixed their exchange rate. However, that ended in 1971, when President Nixon devalued the dollar and severed the gold link between the dollar and gold. Currencies then floated, deficits soared and the US went on a spending spree helping cause the worst inflation in recent history. Gold went from $35 an ounce to more than $800 in the next decade. We believe that the present dollar exchange system of floating non-convertible currencies is ending. Without confidence in the dollar, the world has no valid reserve currency. Today we have come full circle but this time, a return to a gold standard might not come soon enough.
At the very least, a gold standard is the logical solution to take control of the money supply away from the central bank and a new Bretton Woods-style agreement replacing the current flexible currency regime with an asset backed currency, like gold is needed as part of a new monetary era. Ironically, President Trump in stacking the Federal Reserve with nominees of whom he supports, some are sympathetic to a return and discipline of a new gold standard.
A Golden Life Preserver
A third of America’s hefty government debt is financed by foreign investors which needs to be continuously rolled over. The United States is running a huge risk relying on the sustainability of their profligacy. Rather than dump their $1.1 trillion of Treasuries, as Russia has done, China, the largest foreign creditor to the US government could easily abstain from regular auctions because they already have too many dollars. They are sitting on the world’s largest stockpile of foreign exchange reserves at $3.1 trillion dating back when the Peoples Bank of China (PBoC) bought dollars from their exporters in exchange for renminbi to avoid appreciation of their currency. However that ended in 2016, when China surpassed Japan as the largest foreign holder of US debt.
Today after a sequence of events beginning with the wars in the Middle East, continuing with the Trump tariffs, sanctions and unilateral abrogation of agreements, America’s allies no longer trust the United States. What damages trust in the US, damages the whole world. Investors are left wondering whom they could trust. The US government must borrow $1 trillion to finance its widening deficit and without China and foreign investors, the government would need to offer higher rates. Of concern is that a $27 billion auction of 10 year notes almost failed as covered bids were only 2.1 times the amount offered, the lowest coverage since March 2009. With total debt at $22 trillion or 100 percent of GDP, who will buy America’s debt? What happens if China decided to follow Russia and unload its hoard of $1.1 trillion of Treasuries? What if the Fed were to hold another bond auction and nobody showed?
Notably, China’s absence this time is a warning. We also believe a trade truce is unlikely to change the political calculus in Washington. The United States is divided, its currency is vulnerable and dependant upon the international community to tolerate a very unhealthy balance of payments. Under these circumstances, two-thirds of the world’s assets are denominated in a fiat currency issued by a profligate country set on debasing their currency. We thus believe current Treasury offerings are unsustainable because the world’s biggest economy cannot fund itself. History shows that when nations are in trouble, they extricate themselves by stealth debasements through inflation.
Gold has been a disappointment for much of this year, but its weakness does not tell the whole story. Future contracts are influenced by short term factors and for the past few years, billions of paper ounces have been dumped on the market, depressing the gold price. However longer term contracts term were unaffected implying an extremely tight physical market. In fact, the reality is that the Chinese, through the Shanghai Gold Exchange have been the biggest buyers of physical gold, sopping up each available ounce. In May, China added 16 tons, its biggest monthly increase since January 2016. There is a battle between the tightness of the market and futures. We believe that the physical market will win out because of the lack of mine supply, growing central bank demand and a vulnerable US dollar.
In weaponizing the dollar, America undermines the dollar’s role. Its recent isolationist stance and reckless fiscal policies also increases the risk of holding dollars. One consequence is that global central banks have been purchasing gold at the highest rate since 1971, reducing their exposure to the US dollar. Already, among the top six largest holders of gold, the central banks of Russia and China have been steady buyers of gold every month this year. Central banks are the largest holder of gold, an alternative to the dollar.
Gold has lagged most markets because the dollar has been a safehaven choice over the past decade. What happens when investors discover that their life preserver can no longer save them? To be sure the breakout beyond $1,300 an ounce is an encouraging sign. Gold has tried to break the $1,350 level five times and was finally successful in breaking out. With an interim target at $1,700 an ounce, gold is a barometer of investor anxiety. We continue to believe gold will hit $2,200 within 18 months.
Gold’s bull market has just begun.
Gold equities performed better of late as gold skyrocketed to new highs, breaking through the $1,350 an ounce resistance level that existed for almost six years. Gold shares are transitioning from the difficult period of repairing balance sheets to active mergers and acquisition activity on the heels of Barrick's acquisition of Randgold and Newmont's purchase of Goldcorp. Organic growth has been difficult for many and consolidation in the mining business made sense since it is cheaper to buy ounces on Bay Street. All-in-costs has been creeping upward, hurting margins.
We believe that gold prices will go higher given the lack of discoveries and the long lead time to develop and build mines today. This year there are only a handful of new mines expected to open including Agnico Eagle’s Meliadine, McEwen’s Gold Bar in Nevada, the expansion at Sabina and Victoria Gold’s Eagle project in Yukon. As such we remain positive on gold as a hedge against US dollar vulnerability and believe that the senior and intermediate producers with free cash flow and dividends will play an important role in portfolios.
We also believe an over-weighted portfolio position is appropriate at this time. We continue to like Barrick as the go to senior, Agnico Eagle for their execution among the seniors, and B2Gold as a growth vehicle. While, there are a number of gold miners who have yet to join the wave of mergers that is reshaping the sector, some have long term problems. For example, oft mentioned merger candidates, Yamana, Kinross and Iamgold have a host of problems and mergers for the sake of size may not be beneficial for an acquisitor. Kinross for example is hurt by the deadlock with Mauritania's government and its healthy exposure to Russia. Yamana is plagued by $1.6 billion of debt. The industry, burned by expensive writedowns in the last cycle is more cautious this time. For the juniors, the Index ETFs, have made it difficult as most investor attention has gone to the mid-caps. Smaller miners and explorers are suffering due to the lack of capital. Well financed Osisko’s Windfall project or Aurania’s Lost Cities projects are ones to watch, however. While this sector is an exciting place, only a skookum-type discovery will attract investor interest.
• Agnico Eagle Mines Limited (AEM) – Agnico Eagle had a strong quarter. Agnico Eagle brought the Meliadine operation in Nunavut into production in May which will produce 230,000 ounces this year. Mill throughput is expected to average 3,000 tons per day and the plant operated as high as 3,700 tons per day on several occasions. Meliadine came in under budget reflecting Agnico Eagle’s strong execution capability. Agnico Eagle will produce about 1.8 million ounces this year and spend about $600 million. Agnico Eagle acquired the Rand Malartic property adjacent to Canadian Malartic, as that company expands its exploration exposure along the prolific Cadillac-Larder border. Agnico Eagle has an excellent pipeline of projects and reserve potential. Agnico Eagle is one of the few producers to replace their gold reserves last year from eight operating mines in Canada, Mexico and Finland. Meliadine and the Amaruq project are on schedule to help Agnico Eagle produce 2 million ounces in 2020. We like the shares here.
• B2Gold Corp. (BTO) – B2Gold had a strong quarter and is one of the fastest-growing gold miners, reflecting a strong quarter from Fekola, its newest flagship mine producing 430,000 ounces last year at AISC of only $533 an ounce. Already there are plans to expand Fekola. Fekola in Mali is a high-grade producer and contributions from Otjikoto in Namibia, Masbate in the Philippines, La Libertad and El Limo in Nicaragua should produce almost 1 million ounces this year. Noteworthy is that the company generated free cash flow of about $30 million dollars and possesses a strong balance sheet after the Fekola build out. We expect B2Gold to be an active player in the M&A game because of its production base, growing cash flow and quality management team. We like B2Gold here.
• Barrick Gold Corp. (ABX) – Barrick and Newmont's joint venture partnership has taken shape making the new Nevada Gold Mine, the fourth largest gold producer in the world. The consolidation of the assets gives Barrick 61.5 percent and Newmont the remaining 38.5 percent. Importantly, the consolidation allows Barrick freedom not to spend a billion dollars for a new roaster as they can send ore to Newmont's facility. The JV will allow more integrated mine planning, G&A savings, supply chain and fleet synergies. In an effort to resolve the Tanzanian government deadlock, Barrick has proposed to buy out the remaining 36 percent of shares in Acacia for $285 million. The offer is a takeunder and has not generated much of a buzz because of the low bid. However, by cleaning up the remaining shares, Barrick will have the flexibility to resolve the longstanding dispute with the Tanzanian government. We continue to like the shares for its major exposure to Nevada, Africa and South America together with an excellent management team.
• Centerra Gold Inc. (CG) – Centerra has two major assets, Mount Milligan in British Columbia and the open pit Kumtor in the Kyrgyz Republic. Centerra generated free cash flow in the quarter but its shares will remain under a cloud because while Kumtor mine in the Kyrgyz Republic is an excellent asset, chronic government negotiations over the Strategic Agreement remains a problem. Centerra is building the Öksüt mine in Turkey, a heap leach mine with an eight year life which is half complete. Öksüt should be in production by early next year at a capital cost of $220 million and produce 119,000 ounces annually. Centerra has some solid assets but the ongoing problems in the Kyrgyz Republic is a cloud over its prospects. The good news is that water does not appear to be a problem this year at Mount Milligan. As for Kemess, the project is too far off and capex heavy to be included in our valuation. Although Centerra is expected to produce about 700,000 ounces this year, we prefer B2Gold here.
• Eldorado Gold Corp. (ELD) – Eldorado is a mid-tier producer that reported a poor quarter due to delay in sales at the Efemcukuru mine in Turkey. The delay was due to a contract dispute and delays at the port. Eldorado reopened mining and heap leaching at former flagship Kisladag in Turkey and has begun loading ore on the heap leach pad again. At Olympias in Greece, Eldorado reported that performance has improved. Lamaque achieved commercial production in March will produce 125,000 ounces next year. As for Eldorado’s other Greek assets, a stalemate with the government sees investors hoping for a change in government and policies to break the logjam. Eldorado has almost 24 million ounces on reserves but permits are needed to exploit those resources. Noteworthy is that Eldorado still has a debt problem with $600 million in notes due next year, and only $220 million on hand. We prefer B2Gold here.
• Iamgold Corporation (IMG) – Iamgold had a disastrous quarter due to start up problems at Westwood in Quebec due to poor ground conditions which affected production. Westwood has reduced their workforce as they try to get a handle on costs and a new mine plan is expected. Also costs increased at Rosebel and Essakane. Although, Iamgold should produce about 850,000 ounces at a cash cost of about $800 an ounce, all-in-costs are quite high. While the balance sheet has $400 million of cash, Iamgold's problem is the lack of growth. After releasing plans to spend a billion to bring Côté Gold into production, Iamgold did an about face and shelved the low grade project despite attracting partner Sumimoto Metal to purchase a 30 percent interest and entered into a $170 million gold forward sale. Of interest is that Iamgold still includes Côté Gold in their reserves.
We believe Côté’s problem is continuity and a new plan is needed. Iamgold had purchased Trelawney’s Côté project for $600 million and spent millions in development. With Côté shelved and Westwood in a turnaround state, there is little on the horizon, including a potential M&A workout. Iamgold has retained bankers to optimize value but we believe the prospect of lack of growth and stubbornly high costs will limit interest. The shares have bounced on rumours after losing half of its value this year. Although China National Gold is rumoured interested, we do not believe that the Chinese would spend a couple of billion dollars to buy a money losing miner with little growth prospects. Sell.
• Kinross Gold Corp. (K) – Kinross reported a good quarter producing 600,000 ounces with contributions from Tasiast in Mauritania and Paracatu mine in Brazil. Kinross is again working on the Tasiast phase 2 expansion plan but huge capital outlays as well as unsuccessful negotiations with the Mauritanian government who recently change the tax code, negatively impacts the outlook. La Coipa/Lobo-Marte in Chile capex remains healthy with a near billion dollar price tag, which is a nonstarter in the current environment. Fort Knox in Alaska production was lower due to the pit wall slide and high costs. Round Mountain Phase W development is positive, however. While often mentioned as a suitor, Kinross is stymied by its heavy Russia exposure, and albatross-like Tasiast operation. We prefer Agnico Eagle or B2Gold here.
• Newmont Goldcorp Corp. (NGT) – Almost before the ink dried on Newmont’s acquisition of Goldcorp, Newmont was forced to shutdown flagship Penasquito in Mexico because of a protracted illegal local blockade. Penasquito represented almost 45 percent of Goldcorp’s NAV and the Pyrite Leach Expansion was to be a big contributor. After 49 days, Newmont resumed operations and ramped up operations. The next shoe to drop is the announcement regarding Newmont cleaning up Goldcorp’s Canadian operations, starting with underperforming Eleonore in Quebec and the Coffee project near Dawson which will likely be put on the backburner. Also, Newmont has identified almost $400 million in efficiencies and productivity improvements which is optimistic. Asset sales are likely as Newmont attempts to extract value from the Goldcorp acquisition. We prefer Barrick since Newmont will be slicing and dicing for the next few years. With 90 percent of their reserves in America and Australia, Newmont should produce about 5.2 million ounces this year but output will be lower at 4.9 million ounces next year.
Editor’s Note: John Ing is President & CEO of Maison Placements Canada Inc. Mr. Ing has over 45 years of experience as a portfolio manager, mining analyst and investment banker. Maison Placements Canada Inc. is an institutional investment boutique that provides financial services to corporate, government, institutional, and individual investors. The firm offers securities underwriting, distribution, and execution services. Additionally, it provides investment banking services including mergers, acquisitions, and divestures; equity financing; financial and corporate restructuring; valuations; fairness and regulatory opinions; and management advisory. For more information on Maison Placements Canada, visit www.maisonplacements.com.
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