Opposites attract: Market outlook favours barbell approach…
Joe Foster, Portfolio Manager and Strategist for the Gold and Precious Metals strategy at VanEck
Less Liquidity, More Turkeys Could Benefit Gold
While it was disappointing to see gold fall below $1,200 per ounce, current extreme positioning – also characteristic of the lows in 2001 – suggests the price will not remain at these levels. Gold has established a long-term base in the $1,100 to $1,365 range. We now expect some consolidation around the $1,200 level, followed by short covering and seasonal strength that potentially moves the price higher over the remainder of the year.
We believe the Turkish crisis is symptomatic of a larger trend that eventually benefits gold. According to reports, since 2009, the world’s central banks have injected a mind-numbing $13 trillion of stimulus into the financial systems. They are now beginning to withdraw that stimulus. The U.S. Federal Reserve has so far raised interest rates eight times and will likely increase its securities selling from $30 billion to $50 billion per month in October. The Bank of England has stopped easing. The European Central Bank plans to stop adding to its balance sheet next year and may begin to raise rates. As the liquidity that fuelled the expansion is slowly drained away, those areas of the financial system that are most vulnerable will be the first to fail.
We believe Turkey was the first domino to fall, with its years of monetary mismanagement and over-borrowing made possible by low rates and ample liquidity. Bank for International Settlements (BIS) data shows $3.7 trillion of U.S. dollar-based loans have gone into EM countries. As central banks continue to tighten, we expect more Turkeys to come out of the woods. The U.S. may find it hard to remain an island of prosperity.
Gold is a unique asset class due to its uncorrelated nature and its ability historically to perform well amidst global financial turmoil. We think of it as financial insurance. Like health or auto insurance, a small allocation can go a long way when hardship occurs. At VanEck, we have been committed to providing funds dedicated to gold stocks since 1968. There are times, such as now, when it might seem painful to hold a gold position. Some investors may, meanwhile, try to time their gold allocation to minimize the impact of market lows. Regardless of how investors choose to use gold, we aim to provide quality gold products for our clients whenever they feel the need for a financial hedge.
Gold Companies Fundamentals Remain Strong and Able to Weather Current Prices
Most gold companies have ample flexibility to weather a slump in gold prices. Debt has been reduced to levels that are manageable at lower gold prices and many companies have no net debt. The average all-in mining cost for the majors and mid-tiers is around $835 per ounce, while our portfolio is $20 below the average cost. Mining costs exclude exploration, capital projects, and other administrative costs.
When accounting for all the money companies are spending, using a gold price of $1,200, BofA Merrill Lynch Research estimates aggregate industry free cash flow of $2 billion in 2018, rising to $7.3 billion in 2020. While we expect to see higher prices in the fall, we always consider industry fundamentals should prices decline further than expected. At $1,100 per ounce, free cash flow goes to $0 in 2018 and trends to $2.7 billion in 2020. At the $1,100 level we would expect companies to trim discretionary expenses and postpone new mine development. Approximately 10% of global production has all-in mining costs above $1,100 per ounce; therefore, there could be a few high-cost mines that consider curtailed production or closure.