• 396 days Will The ECB Continue To Hike Rates?
  • 396 days Forbes: Aramco Remains Largest Company In The Middle East
  • 398 days Caltech Scientists Succesfully Beam Back Solar Power From Space
  • 798 days Could Crypto Overtake Traditional Investment?
  • 803 days Americans Still Quitting Jobs At Record Pace
  • 805 days FinTech Startups Tapping VC Money for ‘Immigrant Banking’
  • 808 days Is The Dollar Too Strong?
  • 808 days Big Tech Disappoints Investors on Earnings Calls
  • 809 days Fear And Celebration On Twitter as Musk Takes The Reins
  • 811 days China Is Quietly Trying To Distance Itself From Russia
  • 811 days Tech and Internet Giants’ Earnings In Focus After Netflix’s Stinker
  • 815 days Crypto Investors Won Big In 2021
  • 815 days The ‘Metaverse’ Economy Could be Worth $13 Trillion By 2030
  • 816 days Food Prices Are Skyrocketing As Putin’s War Persists
  • 818 days Pentagon Resignations Illustrate Our ‘Commercial’ Defense Dilemma
  • 819 days US Banks Shrug off Nearly $15 Billion In Russian Write-Offs
  • 822 days Cannabis Stocks in Holding Pattern Despite Positive Momentum
  • 823 days Is Musk A Bastion Of Free Speech Or Will His Absolutist Stance Backfire?
  • 823 days Two ETFs That Could Hedge Against Extreme Market Volatility
  • 825 days Are NFTs About To Take Over Gaming?
Another Retail Giant Bites The Dust

Another Retail Giant Bites The Dust

Forever 21 filed for Chapter…

How The Ultra-Wealthy Are Using Art To Dodge Taxes

How The Ultra-Wealthy Are Using Art To Dodge Taxes

More freeports open around the…

Is The Bull Market On Its Last Legs?

Is The Bull Market On Its Last Legs?

This aging bull market may…

  1. Home
  2. Markets
  3. Other

Gold: the Audacity of Hope

What all the wise men promised has not happened, and what all the damned fools said would happen has come to pass.

~ former British Prime Minister: Lord Melbourne

Within days of the Budget Control Act of 2011 (aka debt-ceiling agreement) and another Eurozone bailout, global stock markets went on a roller coaster ride amid worries about the US economy and widening European debt crisis. Law makers didn't solve fundamental problems, they just created new ones. Standard and Poors' downgrade of the United States' AAA rating was the first ever, triggering a flight to liquidity. While the debt agreement temporarily soothed the market's concerns, law makers on both sides of the Atlantic drew attention to the mounting debt load, and unwittingly caused a crisis of confidence. Gold hit another record high in a flight to safety. Wall Street has panicked.

The World Has Reached Its Debt Ceiling

In 2008, the massive debts of Wall Street were transformed into taxpayer debt via bailouts. Federal debt increased from $9.2 trillion in 2007 to $14.3 trillion this year, an increase of 55 percent. Soon after money supply too, skyrocketed at double digit rates. Mr. Obama alone has racked up $4.2 trillion in national debt and his term is not yet over. Then Iceland, Ireland and Greece saw their excessive debt transformed into public debt via more bailouts. In Europe, we have a monetary union without a fiscal union. The solution to debt it seems is more debt. The world has reached its debt ceiling ensuring subdued economic growth for many years. It's the same debt, and the same crisis as 2008. It's only bigger and now too political to deal with its consequences.

Italy's debt to GDP is 120 percent, with Italian bonds yielding 6 percent. Greece's debt is 150 percent of GDP, and after the default, their bonds yielded 28 percent. The United States' debt to GDP stands around 100 percent but will go up to 120 percent within two years following this year's budget deficit of $1.6 trillion. Today, US bonds yield about 3 percent, however when US debt to GDP increases to Italy's 120 percent, logic dedicates that bond yields should at least double to six percent.

To keep borrowing money, the United States must pay higher interest rates. Loans, mortgages would become more expensive. Yet rather than see cuts in spending or even a boost in revenues, the Fed in Alice in Wonderland fashion instead declared a freeze on interest rates ensuring negative real yields for the next couple of years. The yield on the benchmark 10 year US Treasury fell below 2 percent for the first time in 60 years. This is far from a solution to America's climbing debt load. The Fed is left to dole out more devalued dollars in hopes of sparking another liquidity driven rally, letting the dollar go down further. What a solution. Cheap money didn't work last time and won't work this time. US debt simply has become riskier. The world doesn't need more money, just less debt.

What happened?

First, Mr. Obama appears to be in the running as a one term president, bitterly dividing the country, out spending his predecessors and overseeing the first downgrade in America's history. Despite much talk about "getting it done", he ignored his own Debt Commission findings, gave short shrift to Republican Ryan's budget proposals and left the solution to Congress. Reality set in.

The debt-ceiling debate and hapless policy responses to US and Eurozone sovereign debt problems point to a deep dysfunction within the global financial system. Arbitrary deadlines, blame game headlines and intransigence created a "made in Washington" crisis in the pursuit of laying the first platforms for the 2012 election. The current crisis of confidence is due to governments' propensity to rescue economies with more trillion dollar bailouts causing their deficits to explode. Those deficits were monetized with printed money. Bigger governments caused bigger problems.

Having trusted politicians and policy makers to fix the economy, investors have capitulated. The debt-ceiling impasse and yet another Eurozone bailout was bad enough, but our politicians' inability to help and make matters worse, affected the audacity of hope. So rather than face their problems, policy makers exposed the vulnerability of the size of America's debt and also that its law makers no longer regard their financial obligations as obligations. Monetary and fiscal policy are interconnected. For some, spending was more important than national default. And for many, fixing the economy by printing trillions of dollars (or quantitative easing) appears to be the least painful alternative. The US then is really no different than Greece in that paying one's debt is someone else's problem.

America's Debt Is No Longer Risk-Free

The other unintended consequence of America's intransigence is the remaking of the global monetary system. With 50 percent of its debt held overseas, China and America's other creditors have a chance to break free of the greenback. It is clear, that America's creditors can no longer trust or rely on the full faith and credit of the US government. Confidence in the dollar, its policy makers and the Fed has simply disappeared. Purchasing dollar assets with China's vast foreign exchange reserves has become more risky today particularly with nominal rates insufficient to compensate for the risk. The situation is clearly unsustainable. American debt is no longer risk free. Similarly, the European Central Bank's prescription of expanding money supply and doling out money every time there is a problem is at an end. And, like the Great Depression, competitive devaluations and currency wars are next when every country pursues its own "beggar thy neighbour" policy. Germany alone cannot prop up the EU.

The real and present danger is that there are no "safe" investments. In late 2008, America's financial problems revealed that no institution was too big to fail. Today, the sovereign debt crises show us that no country is too big to fail. This "damn fool" believes that as the contagion spreads, short term funding issues will become a problem with liquidity concerns addressed by more bailouts but this time the "fine print" of derivatives that once protected investments will cause a collapse in the derivative "house of cards". Exotic financial instruments such as credit default swaps (CDS) or collateralized debt obligations (CDOs) were behind the near collapse of the US banking system in 2008 and the bedrock of the so-called shadow banking system. Derivatives are inextricably intertwined with the debt of the international monetary system and a default would impair the collateral and foundation of the bank funding operation. These bailouts really need bigger buckets. Gold anyone?

And now, the increase in world debt has filtered into prices pushing up inflation. Inflation is convenient for governments because it allows them to devalue their debt making the real value of the debt load worth less than when the debt was contracted. In China, inflation is at 7 percent and in the UK it is 5 percent. Inflation in the US increased to 3.6 percent. The US dollar devaluation has already boosted prices some 30 percent and the promise to keep short term interest low for two years, ensures a hyperinflationary outcome. The underlying truth is that by monetizing debt opting for an inflationary outcome, the developed countries not only devalue their currencies, but also nationalise the private sector wealth in a move reminiscent of the early days of the Weimar Republic or French fiat inflation.

Is Gold's Run Over?

Gold's new highs are bringing out the usual warnings about bubbles and that prices are due for a collapse. Some even point to gold's finite value as reasons that it will never become a mainstream asset. That is the point. It is not gold's scarcity value but its ability to retain its value that will attract investors. Unlike the dollar, it cannot be printed. While the dollar certainly is a mainstream asset, it cannot be said to hold it's value, losing almost 90 percent of its purchasing power against gold in the last forty years. Or when good times return, pundits say, gold will collapse. What happens if good times don't return and record gold prices don't undermine but encourage accumulation. Already, Chinese buyers are buying gold at such a fast pace that they have displaced India as the world's top buyers. In Europe, despite record prices, gold is being purchased as a hedge against a falling euro, and in the US, gold is being hoarded as a hedge against a devalued dollar.

To individuals, institutions and governments, gold is simply the antidote to currency debasement and by default, the world's newest old reserve currency. In addition to a fiscal restructuring, needed is reform of the global financial system and a fundamental redesign so that it better reflects the realities of today's globalised world, interests of both East and West and the discipline of real money. A basket of regional currencies tied to gold instead of paper assets is a good starting point.

By Default Gold Is The Newest Old Currency

In the 1920s, the key currency was the pound sterling, but the cost of fighting WW1 ended its 100 year run when Britain was forced to abandon the gold standard in 1931. The US dollar replaced sterling under the Bretton Woods' agreement which made the greenback convertible to gold. The dollar survived depression and wars. But to prevent a run on the dollar, Nixon closed the gold window in 1971 severing both the link with gold and the fixed-exchange rate system. Under a paper money system, America paid its bills with fiat dollars. What followed was the Great Inflation, as Nixon, like Lyndon Johnson overspent and over borrowed on wars and social programs, paying debt with ever increasing amounts of printed dollars. Money supply and inflation skyrocketed in the seventies and eighties, and the threat of hyperinflation was ended only when Fed Chairman Paul Volcker vowed to print less money to bring down inflation with double digit interest rates. The gold price rose from $35 an ounce to more than $850 an ounce.

While the dollar today is no longer as good as gold, generations of politicians have benefited from this fiat currency and in an era of floating exchange rates, we have had a never-ending series of debt-financed asset bubbles and financial crises, unknown before 1971. Whenever trouble came, central banks cut interest rates, added fiscal stimulus and quantitative easing to the policy mix. Today, the dollar has lost much of its value, falling to less than 1800th of an ounce of gold from the 35th an ounce set under Bretton Woods only forty years ago. Central bankers instead of becoming stewards of money became creators of money.

For more than five thousand years, gold was money whilst the dollar has enjoyed less than a forty year history. In today's uncertain world the yellow metal is back in vogue. Gold has recorded new highs every year for the past ten years as a store of value particularly against depreciating currencies. Gold also benefitted from the diversification away from equities and emerged as a distinct asset class. Importantly, despite the move, gold is under-owned. Indeed, the line-up for gold is for the sellers who are cashing in their jewellery at "cash for gold" entities. When these sellers become buyers, only then we will worry. And for the first time in twenty years, central banks once suppliers to the market have been buying gold, partly because they are awash with dollars which are depreciating every day. In the last quarter, in an effort to reduce their dependence on the dollar, central banks quadrupled their purchases.

Hyperinflation Now

Today, two thirds of the world's assets are denominated in US dollars. Debt is at record highs. The Fed was able to create ever-increasing amounts of newly minted dollars with which to redeem their debt at par. No one it seems was bothered that the fast multiplying dollars actually caused a loss of about 90 percent purchasing power of the dollar. Today, what ballasts the US monetary system is debt, and lately this debt no longer retains its value.

As a consequence, there is a growing decline in confidence in every part of the world, in fact a crisis of confidence. Half of America's debt is held by offshore borrowers, including China, the world's newest economic superpower. China, is showing signs of concern and frustration that the world's central banks continue to use their fiat currencies to pay their bills. China has a long tradition of hoarding gold after a bout of hyperinflation in the thirties. This fear explains why the reactionary idea of returning to a gold standard is enjoying some sort of renaissance. Shell shocked investors would agree.

Some time ago, we studied twenty-five episodes of hyperinflation in the past fifty year period. Common to all was deficit spending and the printing of money became so addictive and politically expedient that few governments managed to reverse the downward spiral. We believe that we are past the tipping point. A study of the hyperinflation episodes reveals that most were preceded by up to a decade of excess government spending and a massive increase in the supply of paper money to finance sovereign government debts, usually over 100 percent of GDP. And in all hyperinflation episodes, governments abandoned a tangible backing such as gold and silver in favour of a fiat currency and some even created financial instruments (early derivatives) as substitutes for money. And so today as before, the world's growing debt load has undermined faith in a faith-based dollar and the direct purchases of federal debt for the first time in a half century resembles the desperate actions by the French or Weimar central banks in their unsuccessful fight to avoid hyperinflation. This "damned fool" believes hyperinflation is next. Gold is the ultimate hedge against inflation.

So the rise in the gold price does not come as a surprise to us. Earlier this "damn fool" forecasted gold would average $2011 in 2011. We continue to believe that gold's run has only just begun. While $1800 might seem high, it is only seventy-five percent of the adjusted inflation 1980 high of some $2400 per ounce. Gold rose nearly 2500 percent from 1971 to 1980, but is only up some 500 percent since its low in 1999. A return to monetary discipline is needed. If not, prepare for a hyperinflation outcome. Either way, gold will be a good thing to have.

All that Glitters is not Gold

Gold mining shares have underperformed gold bullion markedly. Right now the most asked question posed is how high the gold price, but the next is why have gold stocks not performed better? Gold has risen 67 percent since the beginning of 2010, but the gold index only increased 24 percent. Gold companies are trading at significant discounts to the TSX Composite and companies like Barrick can even be bought at only 10 times next year's earnings. Moreover ETFs have garnered much attention holding a record 2,217 tonnes of gold. In the past, gold stocks traded up to three to four times leverage on gold's move but today are at a discount.

There is no doubt that fears of resource nationalization have also hurt share performance, particularly the South Africans where there are renewed threats of nationalisation. In Venezuela, Chavez, repatriated $11 billion of gold reserves and nationalized his nascent gold industry. In addition, from Mongolia to Peru to Tanzania to PNG to Australia, governments are clamouring more from the golden goose. In the current quarter, labour, energy and the capital cost of building new mines have sky-rocketed, (at one time it used to cost $200 million to build a mine and now we talking $5 billion) putting a damper on new mine construction. Geo-political risk is a major influence.

Another reason is that gold shares are often "bundled" as a structured financial product by derivative players who link or hedge the basket against others in a corresponding trade to achieve better returns and of course generate more fees. Ironically, the rash of dividend increases makes the inclusion in a basket more complicated and could lessen the downward pressure by the shorts.

The main reason however for gold stocks' underperformance is that in the quest for growth, gold miners have acquired other gold miners using their paper as currency, causing excessive dilution. Kinross' $7.1 billion acquisition of Red Back resulted in 50 percent dilution. Goldcorp acquired Andean for more than $1,000 an ounce but used its shares. And two years ago Barrick paid for their hedging mistake by issuing almost $6 billion of paper. Simply the gold companies have been gored by their own petard as they have become serial issuers.

A useful valuation metric is market cap per ounce of reserves (p+p) which gives an indication of its market's valuation of ounces in the ground. Today the gold miners are extremely cheap on an historic basis. The top ten gold producers are trading at almost an 80 percent discount to gold or only $362 market cap per ounce of reserves. It is cheaper to buy ounces on Bay Street than build a new mine.

But, not all gold stocks have performed poorly. New Gold has doubled. The juniors have done well because of their potential for growth in resources and in some cases some very exciting exploration plays. Indeed, we believe they are many explorers of gold that have ten-bag potential from here. Some will become takeover targets.

We continue to suggest an over-weighted position to the gold equities group with expectations of gold shares closing the performance gap with bullion. Notwithstanding recent moves, we believe that a spike in gold stocks is at hand. Gold stocks are very much under-owned with most portfolios holding less than 5 percent in contrast to the almost 15 percent weighting on the TSX Composite. Bull markets always climb walls of worry. As such we continue to recommend Barrick, Agnico Eagle, Eldorado, Centerra, and among the more junior ones we like Aurizon, St. Andrews Goldfields, Detour Gold, US Gold, Centamin and silver players, Excellon and Mag Silver. Detour and Allied Nevada are potential takeover targets here.


Agnico-Eagle Mines Ltd

Agnico Eagle reported a strong second quarter reflecting production from Pinos Altos in Mexico and improvements at the big Meadowbank mine in Nunavut. Meadowbank was negatively impacted this winter but the secondary plant is finished. Agnico-Eagle's management has been able to execute the arduous process of bringing five new mines into production. Yet Investor impatience penalized the stock due to concern over the usual teething problems. However, Agnico-Eagle's management is considered one of the best in the industry and their underground miners have lots of experience. In addition, the Company has been expanding its flagship La Ronde where there is potential at depth to the east and west. We believe that Agnico-Eagle with over 21 million ounces of reserves has one of the best potential profiles for rising production and reserves. Buy.

Allied Nevada Gold Corp

Allied Nevada reported net income of $0.04 a share and boosted reserves to 10.2 million ounces. Although the stock appears expensive relative to its peers, part of the reason is that flagship Hycroft in Nevada is currently operating as a heap leach producer. However, next year's production will be boosted as the Company mines the sulfides and the Company plans a mill feasibility study, that will significantly expand its operation at a reasonable cost. Silver sulfide production of 1 million ounces annually significantly improves economics and could be a major producer by 2015. Allied's management have been capable as far as execution and we believe that the Company's shares are attractively priced. Allied will spend $25 million on exploration this year at Hycroft and $8 million at Hasbrouck, a potential second leg. Allied is an ideal takeover target.

Barrick Gold Corp.

Rising prices helped Barrick with second quarter earnings up 35 percent or over one billion dollars in the quarter. Production was almost 2 million ounces at a cash cost of $445 an ounce. At Pascua-Lama on the Chilean/Argentinean border, costs have jumped to $5 billion and first production pushed back to mid 2013. Barrick's estimate of Cerro Casales in Chile has jumped to $6 billion from $4.2 billion, making that project unlikely. The cost of producing an ounce of gold is getting more expensive and the big Pueblo Viejo capital costs have increased to $3.8 billion although output will remain at 650,000 ounces annually.

Barrick is the world's largest gold producer with 140 million ounces of proven and probable reserves in the ground. Barrick's market cap per ounce of reserves is at a modest $344 an ounce. Despite the higher capex, we continue to view Barrick as undervalued and with an excellent management team the Company is capable of exploiting its 140 million ounce inventory. To be sure, the much ballyhooed acquisition of Equinox will generate over a billion in cash flows allowing Barrick to not only finance its larger projects but also finance yet another acquisition, gold this time. Barrick maintained its gold production guidance at 7.6 million to 8 million ounces and we saw nothing in the first half to change that. We continue to like Barrick here.

Centerra Gold Inc.

Centerra is among the cheapest producer due in part to concerns over its Kumtor mine in Kyrgyzstan. Kumtor is the largest gold mine in central Asia with a reserve base of 8.2 million ounces, producing 155,000 ounces in the quarter. Centerra will produce in excess of 620,000 ounces this year at $450 per ounce. Kumtor is an open pit mine and a couple of years ago the government acquired a 33 percent interest providing protection from nationalisation fears. Centerra is attractively priced with almost $500 million in cash and we recommend the shares here.

Centamin Egypt Ltd.

Centamin shares were beaten up as the Arab Spring hurt Egyptian-based companies. However, we believe that the fears are overdone and Centamin has been on target with its output and should produce about 210,000 ounces at a cash cost of $550 an ounce. Sukari is a huge open pit and Centamin has a 9 million ounce plus reserve base. The Company commenced an underground operation which could significantly boost resources currently outlined. Sukari is located in the Eastern Desert of Egypt and is 100 percent owned. A stage 4 expansion to 10 million tons at a cash cost of $255 million will be completed by 2013. The Company has installed an oxygen plant and other than the odd problem, Centamin has been a solid producer. Centamin has $200 million in cash and no debt. Centamin also has eight rigs on site and drilling continues. The shares are undervalued here.

Detour Gold Corp.

The majority of funding is in place at Detour which ensures the development of the big Detour Lake deposit in north-eastern Ontario that contains almost 15 million ounces of gold. The Company expects annual production of nearly 650,000 ounces of gold annually and a mine life in excess of sixteen years. The Detour Lake property is in the backyard of the majors and was once a former producer operated by Placer Dome. However, the jump in the gold price has made this low-grade deposit profitable. In last year's feasibility study, the capital costs were estimated at close to $1.2 billion and Detour Gold is on target to financing the anticipated costs. Pre-stripping will begin before yearend. The project is expected to be commissioned by early 2013 and we believe that Detour is a prime takeover target because the market cap per reserve is only $156 an ounce.

Eldorado Gold Corp.

We continue to recommend Eldorado for its growth in production and resources from its six mines in Turkey, China and Brazil. Eldorado will spend $54 million on exploration. Eldorado posted record earnings of $0.14 per share in line with expectations. Eldorado brought Efemcukuru in Turkey into production and is expanding its Chinese output. Eldorado will produce 725,000 ounces at $400 an ounce this year. Eldorado also plans to double production at its 100 percent owned Kisladag beginning 2014. We continue to recommend the shares here.

Goldcorp Inc.

Goldcorp results were in line with expectations but like others, costs have crept up. Moreover, the flagship $1.5 billion Penasquito mine in Mexico had a continuation of problems during its ramp-up period (commissioned Sept). Initially there were problems with the two line processing circuit and the Company was running it at two thirds capacity. Problems continued in the second quarter and it appears that output will be somewhat lower by 100,000 ounces to 250,000 ounces reflecting problems with either material handling, hauling, recoveries, or in fact the ore itself. We have for some time felt that Penasquito was an ambitious project and watched the escalation of the capital costs. Costs are still increasing and we are concerned that Penasquito is not as advertised. The key question is whether the ramp-up problems are temporary or in fact a red flag.

Meanwhile Goldcorp has also pared production at Musselwhite in north-western Ontario due to the forest fires, offset in part by Red Lake which will produce 665,000 ounces. The Company is still expected to produce over 2.5 million ounces of gold this year and spend $1.8 billion. We prefer Barrick or Agnico-Eagle Ltd at this time.

Kinross Gold Corp.

Kinross released a second quarter with lower production from Kupol in Russia's far north. Kinross produced 676,000 ounces but the increase was due to the purchase of the balance of Kupol, which cost $350 million. Of concern is that $7.1 billion Red Back's acquisition in Mauritania capital costs increased to more than $3 billon and its production cost increased in the quarter. While Kinross continues its hand waving at Tasiast by boosting the resource, the capital cost continues to rise. As we said many times before, Tasiast is either to be a company maker or company breaker and we believe that the latter is more likely, particularly since Kinross floated a $1 billion debenture to help pay for the project. The price tag keeps rising. At Fruta de Norte in Ecuador the Company has begun at the $700 million capex but is still waiting for permits. A feasibility study is expected this year but it will likely contain higher costs and delays. Finally Paracatu in Brazil costs continue to escalate and costs are more than $740 an ounce. We thus believe that Kinross should be used as a source of funds because of our concern over execution risk.

Larger Image

Analyst Disclosure
Company Name Trading Symbol *Exchange Disclosure code
Aurizon Mines Ltd ARZ T 1
Barrick GoldCorp ABX T 1
Centamin Egypt Ltd CEE T 1
Centerra Gold Ltd CG T 1
Detour Gold DGC T 1
Eldorado Gold Corp ELD T 1
Excellon Resources Inc. EXN T 1,6,8
MAG Silver MAG T 1
USGold UXG T 8
Disclosure Key: 1=The Analyst, Associate or member of their household owns the securities of the subject issuer. 2=Maison Placements Canada Inc. and/or affiliated companies beneficially own more than 1% of any class of common equity of the issuers. 3=<Employee name> who is an officer or director of Maison Placements Canada Inc. or it's affiliated companies serves as a director or advisory Board Member of the issuer. 4=In the previous 12 months a Maison Analyst received compensation from the subject company. 5=Maison Placements Canada Inc. has managed co-managed or participated in an offering of securities by the issuer in the past 12 months. 6=Maison Placements Canada Inc. has received compensation for investment banking and related services from the issuer in the past 12 months. 7=Maison is making a market in an equity or equity related security of the subject issuer. 8=The analyst has recently paid a visit to review the material operations of the issuer. 9=The analyst has received payment or reimbursement from the issuer regarding a recent visit. T-Toronto; V-TSX Venture; NQ-NASDAQ; NY-New York Stock Exchange


Back to homepage

Leave a comment

Leave a comment