Making Sense of the Mega Merger Mania

Gold Rides Momentum to New High

The gold price had advanced in January with the U.S. Federal Reserve’s dovish response to the December stock market volatility. This provided the momentum for gold to move to a new yearly high of $1,346 per ounce on February 20. Gold then pulled back to finish the month with a gain of $7.90 (0.6%) at $1,313.31. In early March gold has fallen to the $1,290 level. Following gold’s strong 2019 performance, it is too early to tell if this pullback is a consolidation within an uptrend or a return to the sideways range-bound trading that has characterized the price pattern since 2013.

The strong central bank buying that characterized 2018 seems to be continuing. China purchased gold for the second consecutive month, buying about 12 tonnes in January. Azerbaijan has decided to nearly double its gold holdings to 100 tonnes. Meanwhile, Romania has announced plans to move its 103 tonnes of gold reserves from London to in-country vaults.

For the month, gold stocks slightly underperformed gold. The NYSE Arca Gold Miners Index1 declined 1.6%, while the MVIS Global Junior Gold Miners Index2 fell 1.2%.

Stock Market Highs Pose Headwinds

The stock market has become a headwind for gold as the S&P® 500 is once again poised to make a run at new all-time highs. Complacency is creeping back, which weighs on safe haven 3 investments. Each Fed Chairman since Alan Greenspan has been accused of protecting the stock market with monetary policies. Chairman Jerome Powell was thought to be more hawkish and immune to the whims of the market as he took office. However, the Fed’s policy pause in response to stock market volatility in December has shown Powell to be as sensitive to the markets as his predecessors. David Rosenberg of Gluskin Sheff4 believes the proliferation of exchange traded funds (ETFs), quantitative models, algorithmic trading, and momentum investing are all perpetuated by central bank suppression of risk premia, creating artificial market conditions where pricing is divorced from fundamentals. Ten years after the financial crisis, and economies are so fragile that central banks are still being called to the rescue.

Weakness in housing, automobiles, retail, and manufacturing combined with the lagged effects of the Fed’s tightening in 2018 could again weigh on the stock market in 2019. Another selloff might may be the catalyst gold needs to break through its price range.

Newmont/Barrick: From Supermajors to Super-Duper Major… Or Not?

Merger and acquisition activity has now reached the ultimate level in the gold industry. It started with the September announcement of the friendly Randgold Resources/Barrick Gold (6.2% of net assets) merger, which was essentially a reverse takeover that left Randgold’s management in charge of the new Barrick. Then, in January, Newmont (5.8% of net assets) announced a friendly takeover of Goldcorp (1.8% of net assets), which goes to a shareholder vote in early April. In each case, the managements of Randgold and Newmont believe they can do a better job of creating value than the previous managements of their respective takeover targets.

Barrick and Newmont have spent the last five years downsizing by disposing of non-core properties, streamlining management, and strengthening their balance sheets. Now, in a stark reversal of strategy, they want to grow through mega-mergers. Newmont’s management style is akin to a modern corporate structure, while Barrick under Randgold is more decentralized and entrepreneurial. Each believes their respective management and assets are superior. We will look for evidence of their success, or lack thereof, in unlocking value with their quarterly reporting. In the fullness of time we will find out if their focus on shareholder returns, operating discipline, and innovation are enough to insure success, and whether one is more effective than the other. We hope competition in the free market brings out the best in both.

In addition to the considerable skills needed to manage so many mines, it may be geologically impossible to sustain a gold company that is as large as these companies are becoming. Absent mergers, the size of a gold company is fundamentally limited by geology. The tier-one properties (with low-cost reserves of over five million ounces) that make up the core of the supermajors portfolios are freaks of nature and extremely rare. Gold deposits are generally limited in size and often discontinuous, with chemistry and rock conditions that can be challenging to manage. Companies have been searching for tier-one gold deposits for nearly 200 years and the surface of the planet has been thoroughly explored. They must search deeper with less success as discoveries become fewer every year.

Now, coinciding with the BMO Global Metals and Mining Conference on February 25, Barrick announced a hostile no-premium bid for Newmont that is contingent on cancelling the Goldcorp deal. Barrick believes it can unlock value in Newmont that would not surface if the Goldcorp transaction is allowed to proceed. This would create a super-duper major the likes of which have never been seen before in this business. Shareholders will soon decide whether Newmont is better off with Goldcorp or Barrick.

Barrick figures that roughly two-thirds of the added value of a merger will come from unitizing their Nevada operations. Newmont and Barrick combined produce about four million ounces per year from the state of Nevada, one of the most prolific gold regions in the world. This comes from operations scattered within a 100 x 100 mile area centered on the Interstate 80 corridor between Winnemucca and Carlin, Nevada. Within Nevada, Barrick has higher production and lower costs, while Newmont has more processing infrastructure. Without Nevada, most of the rationale for the merger disappears.

While we do not know whether Barrick’s bid for Newmont will be successful, it does focus attention on the potential gains that unitizing Nevada would generate for both companies. My experience as a geologist in Nevada, and knowledge of the two companies, suggests there is significant value to be gained from merging their Nevada operations. However, shareholders do not have the data, resources, or technical expertise to comprehensively evaluate such a colossal project. We must trust managements within the companies we own to do this work. On March 4, Newmont released a Nevada joint venture term sheet in response to Barrick’s hostile offer. Barrick has not yet responded. If these two adversaries cannot come to terms on Nevada, we call on them to prioritize their shareholder’s interests by publishing a joint definitive feasibility study that quantifies this value and articulates plans to unlock it for all to see. Once this is done, the best path forward should become obvious.

Commitment to Juniors

Finally, lost amid all this mega-merger mania are the junior companies at the other end of the spectrum. In this range-bound gold price environment, there is little investor interest in the juniors. However, we continue to maintain a portfolio of junior developers with good projects. In this market, we expect our patience to pay off once investors return to the junior sector.

IMPORTANT DEFINITIONS AND DISCLOSURES

All company, sector, and sub-industry weightings as of February 28, 2019 unless otherwise noted.

1 NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold.

2 MVIS Global Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver.

3 Safe haven is an investment that is expected to retain its value or even increase its value in times of market turbulence.

4 Gluskin Sheff + Associates Inc., a Canadian independent wealth management firm, manages investment portfolios for high net worth investors, including entrepreneurs, professionals, family trusts, private charitable foundations, and estates.

Important Disclosures

This commentary originates from VanEck Investments Limited (“VanEck”) and does not constitute an offer to sell or solicitation to buy any security.

VanEck’s opinions stated in this commentary may deviate from opinions presented by other VanEck departments or companies. Information and opinions in this commentary are based on VanEck’s analysis. Any forecasts and projections contained in the commentary appear from the named sources. All opinions in this commentary are, regardless of source, given in good faith, and may only be valid as of the stated date of this commentary and are subject to change without notice in subsequent versions of the commentary. Any projections, market outlooks or estimates in this material are forward-looking statements and are based upon certain assumptions that are solely the opinion of VanEck. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur.

No investment advice

The commentary is intended only to provide general and preliminary information to investors and shall not be construed as the basis for any investment decision. This commentary has been prepared by VanEck as general information for private use of investors to whom the commentary has been distributed, but it is not intended as a personal recommendation of particular financial instruments or strategies and thus it does not provide individually tailored investment advice, and does not take into account the individual investor’s financial situation, existing holdings or liabilities, investment knowledge and experience, investment objective and horizon or risk profile and preferences. The investor must particularly ensure the suitability of an investment as regards his/her financial and fiscal situation and investment objectives. The investor bears the risk of losses in connection with an investment.

Why the gold price rally may continue

We often write about the different market developments that can impact the returns of gold within investor portfolios. The primary factors that we consider are:

• Policy of the US Federal Reserve (Fed)
• Consumer Price Index (CPI) measures of inflation
• Behaviour of the US Dollar
• Levels of interest rates—particularly the US 10-Year Treasury Note
• Gold futures speculative positioning

While we believe that these are among the most important factors that explain movements in the gold price, we couldn’t say that they are the sole determinants as to why the price moves. Technical factors, such as the ratios of gold to US equities, gold to US government bonds, and gold to the US Dollar are also certainly worth considering. Below, we look at these ratios and explore the implications for the gold price.

Gold technicals: the gold price to US equities ratio

Since the end of 2009, there have been two dominant trends within the relationship between the price of gold and US equities, as shown through the performance of the S&P 500.

• From 31 December 2009 to 22 August 2011, the price of gold appreciated by nearly 40% annualised while the S&P 500 only gained about 1% per year
• From 22 August 2011 to 8 February 2019, the S&P 500 gained about 14% per year, while the price of gold lost nearly 5% per year

At the risk of stating the obvious, US equities have been the star performers at the expense of most other asset classes since 2011, gold included. But we’d note that in Figure 1, which shows the ratio of the gold price to the S&P 500, we see a falling wedge pattern. The performance of US equities was strong enough recently to push the line—designed such that it declines when US equities are outperforming gold—outside the lower boundary of the falling wedge. This move was short-lived, and technicians have noted that when moves like this fail to establish a trend, the reverse move may occur quite quickly. This suggests that gold could potentially outperform US equities in the near term.

Figure 1: The relationship between gold and US equities may be changing

Source: Bloomberg, with period from 31 December 2009 to 8 February 2019. Concept for chart from blog post by JC Parets on 6 February 2019. Historical performance is not an indication of future performance and any investments may go down in value. You cannot invest directly in an index.

Gold technicals: the gold price to long-maturity US government bonds ratio

One of the big debates among investors today is in relation to where US interest rates—particularly long-term US interest rates—may go to from current levels. From the early 1980s to the present, the trend has clearly been down, leading to massive price appreciation for bond investors. Now, however, with interest rates near historic lows, many hypothesise that the next 10 or 20 years could look very different to the last 30 to 40 years.

In Figure 2, we show the ratio of longer-dated US government bond cumulative returns against the price of gold, using the ICE US Treasury 20+ Year Index as a measure of the returns from US government bonds. The chart shows:

• From 2004 to 2011, the price of gold outperformed longer-maturity US government bonds, resulting in an upward trend in the ratio
• From 2011 to about 2014, longer-maturity US government bonds outperformed gold, resulting in a downward trend in the ratio
• From 2014 onwards, we have observed a strong multi-year basing process, and it looks like the price of gold is again starting to outperform long-maturity US government bonds

While this ratio cannot guarantee that the price of gold will outperform longer-maturity US government bonds going forward, we think that the ratio is an interesting way to consider a longer-term historical context and relationship between the two assets.

Figure 2: Gold may be poised to outperform US government bonds

Source: Bloomberg, with period from 31 December 2004 to 8 February 2019. Concept for chart from blog post by JC Parets on 6 February 2019. Historical performance is not an indication of future performance and any investments may go down in value. You cannot invest directly in an index.

Gold technicals: major trends in the relationship between the US Dollar and the gold price

Gold (and many other commodities) is priced in US Dollars, leading to a natural tendency of the price of gold to rise as the value of the US Dollar falls. Figure 3 indicates that since the late 1960s, the US Dollar has had four regimes of significant depreciation. It is clear that the price of gold responded during these periods by moving significantly higher.

On the right-hand side of Figure 3, we indicate that a pattern has developed recently that looks similar to patterns that we have seen in the past prior to a big US Dollar move down and a subsequent upward move in the price of gold. While this pattern is by no means a guarantee of future performance, we do believe that analysing the long-term relationship between the US Dollar and gold is helpful in stepping outside the minute-by-minute, hour-by-hour, and day-by-day short-term analysis that the world has become accustomed to.

Figure 3: The US Dollar versus gold price relationship since the late 1960s

Source: Bloomberg. Periods of the US dollar are defined as Sept. 1969 to June 1973 (Period 1), June 1976 to June 1980 (Period 2), December 1984 to December 1987 (Period 3) and June 2001 to March 2008 (Period 4). Periods of the gold price are December 1969 to December 1974 (Period 1), Sept. 1976 to Sept. 1980 (Period 2), December 1984 to December 1987 (Period 3) and March 2001 to Sept. 2012 (Period 4). Concept for chart from blog post by JC Parets on 6 February 2019. Historical performance is not an indication of future performance and any investments may go down in value. You cannot invest directly in an index.

Conclusion: the price of gold may appreciate further

We have written recently that, based on our forecast and internal models as of 31 December 2018, gold’s price could reach $1,370 per troy ounce by 31 December 2019. This forecast was based primarily on fundamental factors, rather than technical factors. However, analysing the three charts above, we believe that gold’s further appreciation could also be supported from a technical perspective.

This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.

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Focusing on Gold’s Resilient Base

Focusing on Gold’s Resilient Base

Gold and Precious Metals – Focusing on Gold’s Resilient Base

Gold Trended Higher Early, But Ended April Slightly Down as Dollar Strengthened

Gold trended higher in early April due to trade tensions between the U.S. and China, prospects of airstrikes on Syria, and heightened inflation expectations following a higher than expected March Producers Price Index (PPI)1 and a 2.1% annual rise in the core Consumer Price Index2. Gold topped at $1,365 per ounce on April 11. This level has been the proverbial price ceiling for gold since 2014. Gold subsequently moved lower as a number of generally positive economic releases enabled the U.S. dollar to trend to its high for the year on May 1. Gold was also pressured by real rates that moved higher with U.S. Treasuries. The yield on the 10-year Treasury surpassed 3% for the first time since 2013. For the month, gold incurred a small loss of $9.65 (0.7%) to finish at $1,315.35 per ounce.

Despite No Surprises in Earnings, Gold Stocks With Small Gains

While there was a lack of positive surprises in first quarter earnings, gold stocks were still able to eke out gains as the NYSE Arca Gold Miners Index (GDMNTR)3 rose 1.7% and the MVIS Global Junior Gold Miners Index (MVGDXJTR)4 advanced 1.8%.

Gold’s Resilient Price Floor Has Been Rising Since 2015; Likely to Be Tested Again

While $1,365 per ounce has been the ceiling for the gold price, the floor has been rising consistently since 2015 in a positive trend of higher lows. The base of this trend is currently around the $1,285 per ounce level. As expectations for a June 12 Fed rate increase mount, gold might test the trend’s base in the coming month. Given the resilience the gold price has shown amid concerns over geopolitical risks, trade tensions, and inflation, we would be surprised to see gold fall below this level. Perhaps gold will take another run at $1,365 in the second half of 2018.

Response to Earnings Highlights Lack of Interest in Gold Stocks

A lack of interest in gold stocks over the past year has caused them to fall short of performance expectations, which we highlighted anecdotally in our March commentary. In an April report, RBC Capital Markets was able to quantify this by looking at performance following earnings beats and misses over the last five years. They found that the sustainability of gains from earnings beats has declined in the last two years. Meanwhile, losses on earnings misses have gotten much worse in the last 1-2 years and the loss is sustained over a longer period. RBC also found that the value traded per day in 2018 is at levels last seen at the end of the bear market in 2015, when gold bottomed at $1,050. This points to a lack of buying interest. Absent are those momentum players that follow the winners who beat and value players that pick up the losers who miss. While this lack of interest sounds negative, we are excited by the opportunity it presents. We believe gold equities are undervalued, and the companies are fundamentally sound. A spark that moves the gold price through its $1,365 ceiling may rekindle interest in the miners.

“Gold is Where You Find It”

According to an old prospector saying, “Gold is where you find it”. Many of the companies we follow have found it in very out-of-the-way places. Not next to a highway in Ohio, but near a glacier in British Columbia, in the Atacama desert at 14,000 feet altitude, or 10,000 feet underground in South Africa. Companies must be skilled at building infrastructure in these remote areas.

Understanding Geopolitical Risk

Gold is also often found in places with geopolitical risk. In order to invest in a company, we must be convinced geopolitical risk can be mitigated, if not eliminated by management. Geopolitical risk comes in various forms at the national, state/provincial, and local levels. The most common risks at the national level are changes in taxes or royalties and import/export restrictions. At the state/provincial level, there are risks of legislation that might make mining prohibitively expensive. At the local level, disgruntled groups may blockade an operation and unions sometimes engage in work stoppages. These risks tend to be higher in emerging or frontier countries; however, developed countries are not immune. For example, the largest open pit gold operation in Ontario, Canada has delayed expansion plans to 2026 due to a lack of support from a local Aboriginal community.

Conversely, places assumed to be politically risky to a generalist may, in reality, be very favorable mining jurisdictions. The West African nation of Burkina Faso is one of the best places to build a mine. The gold industry is growing and exciting discoveries are being found. The permitting process is straightforward and efficient. A mining culture has developed, and materials and supplies are becoming more available. While the general election in 2015 was not without drama, in the end there was a peaceful transfer of power. The gold industry is a significant part of the Burkina economy that no leader wants to disrupt.

Argentina and the Impact of Geopolitics on Gold Projects

One of our more successful investments historically was Andean Resources. In 2007, Andean discovered high-grade veins on the Cerro Negro property in Santa Cruz Province of southern Argentina, a part of Patagonia. By 2010, Andean had delineated a 2.5 million ounce reserve, and the company was sold to Goldcorp, Inc. (2.9% of Fund net assets*) for $3.4 billion. The stock gained 1,800% from our first investment in 2007 to the 2010 acquisition. By 2010 it became obvious that the administration of former president Cristina Elisabet Fernández de Kirchner was driving the Argentinian economy into a ditch. The last geopolitical straw came in 2011, when exchange controls were announced and we began to avoid the country due to its growing hostility towards mining and other business.

We took a renewed interest in Argentina in 2015 with the election of Mauricio Macri. President Macri has invigorated business by unwinding exchange controls, export duties, capital restrictions, and many other impediments left from 12 years of Kirchner rule. This year we returned to Argentina to visit gold properties and assess the geopolitical climate. Cerro Negro is now one of Goldcorp’s core operations, producing 452,000 ounces in 2017 with a reserve of 4.9 million ounces. The Macri Administration eliminated a tax on reserves that had essentially stopped exploration spending. Goldcorp started drilling again, and they were proud to show off the Silica Cap discovery. Silica Cap is a vein system that we estimate could bring over 2 million ounces into the reserve.

Photo courtesy of Joe Foster. Drilling the Silica Cap system. Silica Cap outcrops visible as dark patches on skyline.

Another highlight of the trip was Yamana Gold’s (2.7% of Fund net assets*) Cerro Morro project, also a high-grade vein system that aims to start production in May. Yamana was able to draw on its expertise from similar operations in Chile and Mexico. We expect to see a smooth start-up that ramps to 180,000 ounces of gold and 7 million ounces of silver annually.

Yamana and Goldcorp have assets across the Americas, so their exposure to Argentina is limited. While we were pleased with the progress companies are making, there are still concerns that keep us from investing in a pure play in Argentina. Unions continue to exert extraordinary power. They are involved in many aspects of planning and decision-making at the mine level. Work stoppages are not uncommon, sometimes for reasons unrelated to mining that are beyond the control of management. Provincial rules can differ widely. Across the border in Chubut Province, open pit mining and the use of cyanide is banned, which is effectively a ban on gold mining. Inflation is running at 25%, and it remains to be seen if the central bank can bring it back to acceptable levels. Mary Anastasia O’Grady of the Wall Street Journal leads an April op-ed with: “Are Argentines ready to throw off the yoke of peronista populism, thuggery, and politics by roadblock that has destroyed their nation, and to rebuild the free republic of the 19th century?” If Macri can maintain popularity into the December 2019 elections while continuing reforms and taming inflation, then perhaps Argentina again becomes an investment destination for us.

by Joe Foster, Portfolio Manager and Strategist

With more than 30 years of gold industry experience, Foster began his gold career as a boots on the ground geologist, evaluating mining exploration and development projects. Foster is Portfolio Manager and Strategist for the Gold and Precious Metals strategy.

Please note that the information herein represents the opinion of the author and these opinions may change at any time and from time to time.

IMPORTANT DISCLOSURE

*All company weightings, if mentioned, are as of April 30, 2018, unless otherwise noted

1The Producer Price index (PPI) is a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time.

2The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.

3NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold.

4MVIS® Global Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver.

Important Disclosures

This commentary originates from VanEck Investments Limited (“VanEck”) and does not constitute an offer to sell or solicitation to buy any security.

VanEck’s opinions stated in this commentary may deviate from opinions presented by other VanEck departments or companies. Information and opinions in this commentary are based on VanEck’s analysis. Any forecasts and projections contained in the commentary appear from the named sources. All opinions in this commentary are, regardless of source, given in good faith, and may only be valid as of the stated date of this commentary and are subject to change without notice in subsequent versions of the commentary. Any projections, market outlooks or estimates in this material are forward-looking statements and are based upon certain assumptions that are solely the opinion of VanEck. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur.

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All indices named in the commentary are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. An index’s performance is not illustrative of the Fund’s performance. Indices are not securities in which investments can be made.

Tax Reform Adds Fuel to Gold’s Engine

Tax Reform Adds Fuel to Gold’s Engine

Tax Reform Adds Fuel to Gold’s Engine a Gold Commentary July by Joe Foster, Portfolio Manager/Strategist

Gold’s Yearend Pattern Repeated: Oversold Ahead of Rate Increase Then Rebound

The Federal Reserve (the ”Fed”) raised rates for the third time in 2017 following the Federal Open Market Committee (FOMC) meeting on December 12. Since 2015, gold has established a yearend pattern where it becomes oversold ahead of the December Fed rate decision. This pattern repeated again this year as the gold price trended to a five-month low of $1,236 per ounce on the day of the Fed meeting and then promptly rebounded from the Fed-induced low to end December with a $28.11 gain (2.2%) at $1,303.05 per ounce. Commodity price strength also aided gold as copper and crude oil both made multi-year highs in the last week of the year.

Gold stocks also tested their second half lows on December 12 and, like gold bullion, staged a comeback to end December with the NYSE Arca Gold Miners Index 1 (GDMNTR) rising 4.6% and the MVIS Global Junior Gold Miners Index2 (MVGDXJTR) gaining 8.1% for the month.

Strong 2017 Performance on Geopolitical Risk, U.S. Dollar Weakness, and Commodities Strength

Gold and gold stocks performed well in 2017. The gold price advanced $150.78 per ounce (13.1%), the GDMNTR was up 12.2%, and the MVGDXJTR gained 6.2%. These gains were impressive for a market in which investors generally showed little interest in gold while being preoccupied with new records in the stock market, bitcoin, and ancient art. Gold also did not receive much help from the physical markets, as Indian demand remained near the lows of 2016 and China’s central bank refrained from purchasing gold. The resilience in the price of gold came from a global sense of geopolitical risk and uncertainty, overall strength in commodities, and unexpected weakness in the U.S. dollar. Gold stocks typically outperform gold bullion in a positive gold market. However, this year was one of mean reversion after a strong 2016 (GDMNTR up 55%), along with a lack of sizzle that investors are seeing elsewhere. Healthy earnings and increased guidance among gold companies were not enough to capture much investor interest in 2017.

Tax Reform Adds to Deficit, Increases Systemic Risk

Anyone hoping that Washington D.C. would become fiscally responsible under Republican Party rule has seen their hopes go up in flames, as new tax rules appear likely to drive the U.S. deeper into debt. Some say economic growth created by tax cuts will likely generate more government revenue. In a recent Wall Street Journal article, ex-Congressional Budget Office (CBO) director Douglas Holtz-Eakin stated that he believes tax policy can partially offset costs if it is well designed. We believe the new tax code is not well designed, as it is nearly as complicated as the old one, widely unpopular, and contains many provisions set to expire in 2025. The tax windfall corporations will receive comes at a time when profits are high and cheap credit is plentiful. If companies were inclined to spend more on capital expansions, they would have done so already, but instead many companies have used cash to buy back stock and pay dividends. We believe it is too late in the cycle for tax stimulus to have a lasting effect. In addition, fiscal stimulus has limited effects when debt levels are high, as they are today. None of the federal income tax cuts since 1980 have succeeded in shrinking the deficit through growth. The Reagan tax cuts of 1981 could not forestall a recession that started in July of that year, caused by tighter Fed policy. Similarly, any growth resulting from Trump’s tax cuts could give the Fed more latitude to raise rates.

Tax reform will add an estimated $1.5 trillion to the deficit over ten years, according to the Joint Committee on Taxation (JCT). In October, the U.S. Treasury Department reported the budget shortfall increased 14% in 2017 to $666 billion, which is equal to 3.3% of GDP. At $16 trillion, public federal debt is 85% of GDP and Harvard University economist Jason Furman estimates debt escalating to 98% of GDP by 2028. The CBO figures interest charges will consume 15% of federal revenues in 2027, up from 8% currently. The annual report from the trustees of the nation’s largest entitlement programs show the trust funds running out for Medicare in 2029 and for Social Security in 2034. The new tax law only piles more onto this growing mountain of debt.

Total non-financial debt in the U.S. stands at $47 trillion, equal to 250% of GDP and $14 trillion more than at the peak of the last credit bubble when debt/GDP stood at 225%. Thanks to below market rates engineered by central banks, debt service has not yet become a problem. Low rates have forced investors to take on more risk in order to generate acceptable returns. Another side effect is the proliferation of European ”zombie companies”, meaning their interest cost exceeds earnings and kept on life support by banks fearful of losses if the companies declare bankruptcy. The Bank for International Settlements (BIS) estimates that 10% of publicly traded companies in six major European countries are zombies. As central banks embark on tighter policies, at some point higher rates could create debt service problems. Gluskin Sheff3 reckons every percentage point rise in the level of rates will ultimately drain 2.5% out of nominal GDP growth.

Looming Economic Downturn, Decline in Markets Supports Gold Allocation

It appears the only way to stop sovereign debt from growing is through tax increases or spending cuts. By now it should be clear that these options are politically impossible, which suggests that deficits will continue to grow until they cause a crisis severe enough to motivate change. ”Crypto-mania” and a stock market that goes nowhere but up indicates that a crisis is the last thing on investors’ minds. However, in our opinion, we are at a stage in the cycle when concerns should be high. The expansion is heading into its ninth year. The economy is at full employment and the personal savings rate has declined from 6% in 2015 to 2.9% in November. By now many have bought their first home, a new car, remodeled the kitchen, taken that overseas vacation, or bought a second home. Some are in a position to speculate on their favorite ETF, cryptocurrency, or FAANG stock (Facebook, Apple, Amazon, Netflix, and Google). There comes a point when investors are all-in and something happens that triggers a selloff – a geopolitical event, an economic downturn, or a black swan 4 emerges. Markets decline, but there are few investors with the capacity or desire to buy more, so markets decline more. Momentum kicks in and there’s more selling until sentiment turns for the worse. The selloff becomes a contagion that spreads uncontrollably. It has happened to tech stocks and it’s happened to instruments linked to mortgage securities. It is likely to happen again.

Based on the gold price strength following December rate increases in 2015 and 2016, we expect to see firmness in the gold price in the first quarter. However, headwinds may come for gold if economic growth enables the Fed to tighten more than expected. Also, the U.S. dollar might strengthen if the new tax code causes corporations to repatriate profits stockpiled overseas. We believe any weakness in gold during the first half of 2018 could be transitory. Moving through 2018 and into 2019, we believe the chance of an economic downturn increases, along with the probability of a significant decline in the markets. High levels of debt could cause a downturn to turn into a financial crisis. We now know that quantitative easing5 and below-market rates have failed to generate needed growth or inflation. In the next crisis, look for central banks to resort to even more radical policies, such as directly funding treasuries. It is conceivable that there could be global currency debasement on a scale never seen before. In such a scenario, hard assets, especially gold and gold stocks, could significantly outperform most, if not all, other asset classes in our opinion. There comes a time in every economic cycle when investors should seek portfolio insurance. We believe the time is now.

by Joe Foster, Portfolio Manager and Strategist

With more than 30 years of gold industry experience, Foster began his gold career as a boots on the ground geologist, evaluating mining exploration and development projects. Foster is Portfolio Manager and Strategist for the Gold and Precious Metals strategy.

Please note that the information herein represents the opinion of the author and these opinions may change at any time and from time to time.

IMPORTANT DISCLOSURE

1 NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold.

2 MVIS Global Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver.

3 Gluskin Sheff + Associates Inc., a Canadian independent wealth management firm, manages investment portfolios for high net worth investors, including entrepreneurs, professionals, family trusts, private charitable foundations, and estates.

4 A black swan is an event or occurrence that deviates beyond what is normally expected of a situation and is extremely difficult to predict; these events are typically random and are unexpected.

5 Quantitative Easing by a central bank increases the money supply engaging in open market operations in an effort to promote increased lending and liquidity.

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Investors remain sceptical over the recent oil rally

Investors remain sceptical over the recent oil rally

ETF Securities – Investors remain sceptical over the recent oil rally

Highlights

  • Investors continue to sell long positions in crude oil ETPs with outflows of US$36mn last week.
  • In currencies, investors sold out of long ETPs in both the USD and EUR to the sum of US$61m, the largest flows since June 2017.
  • Robotics ETPs posted another strong week of inflows – totalling US$53m – just shy of the record US$56 the previous week.

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Investors continue to sell long positions in crude oil ETPs with outflows of US$36mn last week. With the exception of one week, we have now seen 29 consecutive weeks of outflows. That is similar to the period of outflows seen in 2013/14, just prior to the fall in oil prices in late 2014. To further highlight investor scepticism in the sustainability of current oil prices, we have seen inflows of US$53mn in short positions over the same 29 week period. The oil market currently has two key opposing forces influencing prices: further signals that OPEC and Russia will persevere past 2018 with regards to production freezes, and the most recent IEA report highlighting that they expect US oil production to surpass that of Saudi Arabia. We continue to believe the oil price is likely fall back into the range between US$45 to US$60 per barrel in the coming year.

Precious metals saw broad outflows of US$55mn, with the majority of outflows from silver ETPs, which saw outflows of US$49mn last week, bringing year to date outflows to US$77mn. The current gold:silver ratio is currently at 78, above 1x standard deviation from its average, highlighting silver is historically cheap at current levels after the recent gold price rally.

In currencies, investors sold out of long ETPs in both the USD and EUR to the sum of US$61mn, the largest flows since June 2017. We believe this was due to increasing rhetoric of further tightening from the ECB and worries from investors over rising government bond yields in the US. USD and EUR ETPs saw outflows of US$27mn and US$5mn respectively, further highlighting investor bearishness over the currencies.

Robotics ETPs posted another strong week of inflows – totalling US$53mn – just shy of the record US$56mn the previous week. This brings total inflows this year to US$128mn. Expectations are high for the upcoming earnings season. Consequently Robotics ETPs have outperformed the S&P500 by 5% this year. Valuations remain at 31x, at their long-term average, to the MSCI Global Technology index.

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