December 19, 2017

Gold market haven in 2018

Gold prices have been front-page news for the past few years, despite gold prices remaining resolute and resilient around US$1,250 per ounce. But now that prices have started to creep higher, the case for investing in gold miners at this stage of the cycle seems to make increasingly more sense.

Seen as a safe-haven from inflation-conjuring central bank quantitative easing policies, the yellow metal has felt the brunt of investor fears and investor panic in recent years, with Bitcoin being the latest vehicle to tempt further safe haven gold buying.

When compared to gold priced in Australian dollars, it’s clear that gold is still keeping hold of its allure despite a much stronger US dollar and very frothy equities across the G20.

However, some analysts are questioning the current market strength. As the benchmark ASX 200 consolidates above 6,000, more and more investors will start to consider exposure to gold in the event of a market crash.

Investor attention may have been focused on US equity markets, technology stocks and crypto currencies this year, but gold has still had a decent 2017, delivering double-digit growth during the year. The strong performance is particularly noteworthy in a year when the US has been actively raising interest rates and equities have remained at the top of their respective indices across the developed world including the US.

Gold’s range has been relatively narrow and, apart from the geopolitically-inspired move above US$1,350/oz in September, the moves have been extremely orderly. Given the renewed interest in gold mining, there are now limited development opportunities for mid-cap and mature miners in Australia, due to the dwindling number of available gold projects.

Waning global gold output is spurring more deals and industry consolidation, as mine supply is expected to fall around 30 per cent in the coming 10 years, according to data obtained from BMO Capital Markets and Randgold Resources Ltd.

Gold companies based in Australia have proposed or completed acquisitions worth about $4.5 billion since a rebound in deal-making in 2015. In fact, Australia’s top producers tripled their total cash reserves in two years since 2015 — seeing their aggregated war-chest expand from A$406 million in 2015 to about A$1.4 billion today, according to data obtained by Bloomberg.

However, in 2017 the larger-sized miners including Evolution Mining Ltd. and Northern Star Resources Ltd., Australia’s No. 2 and No. 3 producers, are looking to the US and Canada for acquisitions to add operations of sufficient scale and quality. The huge cash reserves now being held by those Aussie miners could well be deployed in earnest in 2018.

If large-cap miners are not your cup of tea, there are always small juniors that can potentially deliver even higher returns for investors — although small-cap stocks do carry significantly more risk than their larger cousins.

Gold far and wide

Mining and resource exploration are cyclical industries that go through ups and downs, highs and lows, peaks and troughs, just like any other market.

But there are a few noteworthy trends currently in effect which could provide explorers, miners, investors and customers with good opportunities – both in the near-term despite weaker commodity prices and the long-term on the back of technology, innovation and cyclical growth.

One of the most influential market themes of 2017, has been the transformation of yesterday’s relative lack of activity (2014-2016) into relative shortages and rising prices today. In turn, this effect is incentivising new exploration has fed through to higher prices and encouraged more risk taking.

The elephant in the room for gold has been the Federal Reserve, and this factor could potentially be fading next year, as waning US dollar strength provides more leeway for gold to make further gains.

Monetary policy (and macro policymakers) will continue to be significant drivers of gold prices, given that the US Fed is widely anticipated to initiate several rate hikes next year and only commence its balance sheet to contract, from its currently-gargantuan US$4 trillion level. The US dollar maintains a strong correlation to gold, and the relationship is as strong as it ever was. 

As a side-point — the US Fed has not put a dent in its runaway-train balance sheet since the GFC in 2008/2009. Far from it, it has only grown but albeit at a slower pace. With a whole lot of balance-sheet deflation to come, this could well spell US dollar weakness and by default, lead to gold price strength due to a strong correlation.

The new staff roster at the Fed, may also change the way the central bank acts and communicates, thereby inducing further price volatility in precious metals markets given their sensitivity to central bank commentary.

Another factor that threatens gold’s current market balance is expensive equity markets in the US, Europe, Australia and Japan.

The current equities bull market has reduced gold’s appeal in 2017, which means an end to that trend could reignite demand for gold in 2018. The direction of the US dollar is also likely to be highly important, as history has proved. Historically, a higher US dollar has weighed on gold prices and prevented strong sustained appreciation in spot gold. 

If the US dollar get into a trend of unwinding its gains made against all other currencies in 2017, it would signal the end of a multi-year period of US dollar strength and therefore, could provide a positive headwind for gold prices next year.

Written by George Tchetvertakov