What eight years of economic stimulus could not do, Donald Trump's election has generated the biggest stock market rally for any president since Ronald Reagan. Global financial markets continue to adjust betting that the election of Donald Trump and his promises of increased infrastructure spending, tax cuts and reduced red tape will boost the American economy. Soon, we are to have Trump infrastructure, Trump tax cuts, and Trump protectionism. For that, he will need capital. The bond market however thinks differently and yields on 10-year Treasuries jumped 100 basis points and other government debt sank to fresh lows, leaving investors with the worst bloodbath since 1990. For the first time since Eisenhower, the Republicans control both Congress and the White House. Clearly, investors have ignored the downside of a Trump-fueled recovery, so feared before the election. We believe Mr.Trump's turbo-charged growth expectations and the resultant inflation will result in a budgetary binge of colossal proportions. And thus, ironically, the King of Debt will be good for gold.
Make Gold Great Again
Gold however was the biggest loser, reaching 10 month lows following Trump's election as investors feared higher rates and a strong US dollar which sparked exchange traded fund sales. In the wake of Brexit, Trump's victory and now the shock of the Italian referendum, gold's disappointing price action has given rise to bearish scenarios - to be sure the bandwagon is empty. We believe however that the optimism over Trump will clash with the reality of his office and, the inflationary bias of his economic agenda will actually underpin higher gold prices. Thus fears of a retest of the January lows are overblown. We expect current levels to hold with resistance at $1,225 and $1,275 an ounce but rock bottom support at $1,100 an ounce. Simply geopolitical uncertainties remain, the consequence of rounds and rounds of monetary easing are still to be felt and central bank gold purchases continue. Chinese gold premiums have skyrocketed due to shortages of physical gold. And, finally Mr. Trump's team are "hard money" advocates, making restoration of America's balance sheet paramount which could make gold great again as he elevates discussion on how to better mobilize America's gold hoard.
To be sure, the liberal indignation misunderstood the Trump phenomenon. His so-called "deplorables" did not take Mr. Trump's "locking her up" or "drain the swamp" rhetoric literally. Had they, they would not have voted for him. Misreading his message, the Democrats lost the House, Senate, two thirds of state houses and the White House. Simply Americans voted for the hope and promise of jobs and, the audacity was that they did not care much for Trump's casual approach to the facts. They however shared his disdain for the elite and disregard for traditional norms was simply posturing which cost him nothing. Overlooked by the Clintons, the Renzis and Camerons is that voters are fed up with traditional politics. Jobs, jobs, jobs are part of the solution and this president is likely to use his office in a business-like common sense approach, to leverage and 'bully' his way to achieve these goals - for better or worse.
Change is Coming
Part of the problem is that Trump is ideologically agnostic. His recent pronouncements have sometimes pleased the right and then the left, and sometimes both were unhappy. His populist image is contradicted by his recent cabinet appointments. While business avoided the candidate, they were clamoring to join the Chairman of the Board's cabinet. Of course, there are contradictions and potential unintended consequences. Newly-minted Treasury Secretary Mnuchin will repeal the Trans Pacific trade deal (TPP) but NAFTA might be "fine tuned". Trump wants to boost the coal industry, but meets with Al Gore. Then there is Trump threatening a trade war, with its largest trading partner. His pick to lead State, Rex Tillerson Exxon CEO has close ties to Russia but also is a strong supporter of free trade and globalism. The unpredictability of Mr. Trump is his strength. The only certainty is that there will be uncertainty. As such, investors who once paid little for risk will now price in a premium for that uncertainty. Change is coming.
A paradigm shift is underway. The promised dismantling of the much hated Obamacare, Dodd-Frank and Volcker Rule will boost GDP, however infrastructure spending and tax cuts will cost big money and add to an inherited debt load of $20 trillion. Mr. Trump can't have both. It is hard to believe that Mr. Trump could outspend the Democrats but bond investors, fearing ballooning deficits will help drive up interest rates, the dollar and widen America's trade deficits. Money has flowed from the bond market into the stock market sending the Dow over 20,000 and the US dollar to its highest level since 2003, gaining about 43 percent since 2008. Ominously, foreign central banks have dumped almost $400 billion of US debt in the last 12 months as they not only diversified their portfolios but reduced their dollar exposure. China too has dumped $150 billion of treasuries, equivalent to one month of new treasury issuance. China's foreign exchange holdings have fallen to just over $3 trillion since 2014. We believe the honeymoon and boomlet won't last as expectations run ahead of political, budget and legislative branch realities.
How to Make Friends and Influence People
Then there is Mr. Trump's foreign policy that appears to scrap the almost 50 year globalism doctrine, noteworthy because it arrives at a time when the days of US global hegemony is in decline. Mr. Trump's "America First" will represent a seismic shift in the regional and global balance of power and trade. The world will be watching Mr. Trump's future administration with a combination of trepidation and, hope.
However, there is concern that Mr. Trump will relegate international challenges from Europe to Mr. Putin to the Middle East to China to the backburner as he embarks on his "America First" promises. A reduced role internationally, together with an aggressive posture towards America's adversaries and even allies will only heighten America's isolation to the glee of its adversaries. More likely is that Russia, China and Europe will be expected to manage their respective global spheres of influence and rather than get caught up in nation-building, strategic and security interests will be decided by those regional interests.
Five years after nearly breaking apart, the European Union's existence is again threatened with Italian banks laden with $2 trillion of non-performing loans, swamp concerns over the Greek banks and fears of contagion. Italy is the eurozone's third-largest economy and the loss of the referendum is the biggest threat, already buffeted by Britain's intention to leave. The proposed bailout of Monte dei Paschi laden with too many non-performing loans has been derailed by the vote and new elections are likely, too late for Monte dei Paschi. Can Mario Draghi kick this Italian can down the road? Then there is the Bank of England's recent stress test where state-controlled Royal Bank of Scotland and Barclays were found to be undercapitalised and failed once again the stress test. The upcoming Basel proposals were to tighten risk and capital requirements, but now America's loosening or rollback rather than tighten regulations will allow those undercapitalised banks another opportunity to leverage and not fix their balance sheets. What will Trump do?
Meanwhile, global trade also slowed down and this will make it more difficult for his free trading Republican party to endorse his promises of protectionist thirties-style tariffs. Global supply chains are integrated and already high ranking Republicans are balking at import taxes to close the trade deficit gap.
Mr. Trump has yet to follow through on slapping a punitive tariff of 45 percent on Chinese imports. Sino-US relations is one of the main hotspots facing the Trump administration, particularly with his recent challenge of the "One China" policy that underpinned relations for more than 40 years. We believe his "art of a deal" strategy is merely sabre-rattling as a prelude to tough negotiations. China is watching intently and should America introduce tariffs, there are many ways to retaliate such as slapping retaliatory tariffs on those big Boeing airplanes or IPhones.
Consequently, Mr. Xi and Mr. Trump both strongman, might discover rather than confrontations, a pragmatic approach looking beyond the trade and currency irritants would be better off. After all, China and the United States are each other's largest trading partner - they remain intertwined and both have much to lose. The selection of Iowa Governor Terry Branstad, an "old friend" of China for ambassador to China is a positive first step. The US needs China's middle class market and capital. China needs US technology and markets to fuel its next round of growth. Also, China has the capital and the technology to help America rebuild its infrastructure such as highways, bridges, tunnels and airports. However, sabre rattling mistakes like accepting a call from Taiwan's president, questioning the One China policy or entertaining the Dalai Lama could setback any meaningful beginning.
Make America Gold Again
So how to pay for Mr. Trump's spending binge? Asking America's trading partners to foot the bill is unlikely, particularly if Trump tears up trade agreements, makes ill advised tweets or imposes tariffs. We believe, most likely is the resurrection of Reagan's supply side playbook of reducing taxes, government spending and regulation plus the useage of America's gold hoard. America's finances are in shambles and getting worse. What ballasts America's monetary system is debt. Debt on debt is not good.Mr. Trump has inherited a problem, however there are solutions, a golden solution.
There was a time when gold was money. The United States was on a gold standard from 1789 till 1971. For 182 years including the Great Depression, the dollar-based gold standard represented stable money, mainly because there was no artificial limit on the supply of money. Part of gold's allure is it's store of value. The US has the world's largest holding of gold, yet supplies are no longer growing annually, unlike fiat currencies.
The US dollar became the world's reserve currency when America displaced war torn Britain. Gold was fixed at $35 per ounce and other currencies were pegged to the dollar. However, in 1971, President Nixon took the dollar off the gold standard because there were too many claims on American gold reserves because of the liabilities from the Vietnam war and LBJ's Great Society.
In the years following, America enjoyed a virtual unlimited line of credit, simply creating dollars to pay their bills in a currency it prints, allowing them to consume more than they produced. The dollar became the keystone for the international monetary system. Today two-thirds of the world assets are denominated in a fiat dollar backed by the "full faith and credit" of the nation; a defacto dollar standard. For decades, governments, central banks and corporations used dollars. However, the United States kept going deeper in the red, and large trade deficits were the norm.
In the eight years since the financial crisis, relying on unconventional monetary practices and deficits, America flooded the world with dollars in an attempt to resurrect its economy. However, that changed when America's trading partners with growing foreign exchange reserves became alarmed at their dependence on the dollar hegemony. US sanctions caused Russia to look for alternatives. Similarly, Iraq, Iran and others sought alternatives. Foreign creditors of the United States in turn, alarmed at this avalanche of dollars have dumped dollars. Half a world away America's creditors are buying gold. Today the dollar's reserve status hinges on geopolitical politics. We believe that America's isolationist stance together with a more aggressive treatment of its adversaries will erode its reserve dollar status. In today's uncertain world, gold might be a good thing to have - it might even become fashionable again.
Trump and Gold
"We used to have a very, very solid country because it was based on a gold standard," Donald Trump said on July 2015 in a Bloomberg interview. He also said, "we don't have the gold. Other places have the gold."
It is hard to say how Trump's cabinet choices will fare but this Chairman of the Board has emulated Winston Churchill's hand picked war cabinet which not only crossed party lines but consisted of a group of powerful ministers possessing both talent and experience. As optimism spreads about Trump's economic agenda, his economic team similarly ranges from retired generals, a quartet of billionaires, to hedge fund players and the odd seasoned lawmaker whose common denominator is a "hard money" view of limiting the Fed, and for some, a return to the discipline of a gold standard. Rather than "drain the swamp", he is using long time swamp dwellers with a conservative ideologue who embrace a traditional agenda of lower taxes and less regulation. Under the last few presidents, the steady encroachment of individual liberties, including a war on savers became the popular populist Trump complaint. As most of his team are experienced business people and thus transactional-minded, they will play an active role in kickstarting the economy. Treasury-elect deal maker Steven Mnuchin is expected to restore the balance of power making the Treasury Department, the crucial driver of economic policy instead of the heavy handed Federal Reserve which has dominated monetary policy since 2008, with unconventional programmes which failed to lift the overall economy.
Since 1973, Republican administrations have been friendly to gold. Noteworthy is that over those 40 years, after one year in office, gold gained 23 percent versus only 5 percent under Democrat presidents. Few remember that in 1984, Republican Congressman Jack Kemp (ex-football hero), introduced the Gold Standard Act, which required the Federal Reserve to re-establish the linkage of the dollar to gold. Since then, enactment has been a touchstone for many Republicans. Jack Kemp also pushed supply side economics which called for lower taxes and reduced government which helped Ronald Reagan's landslide re-election to a second term. Today many of Kemp's disciples are in the new Trump administration. We believe that rather than tinker around the edges of economic policy, Mr. Trump will reshape the Fed's role starting with nominations of two governors in pursuit of downsizing the interventionist Fed. The imposition of a gold standard, or usage of gold to finance debt would both unite his party and is an elegant way to pay for Mr. Trump's ambitious programs.
Trump's Team and Gold
One of Mr. Trump's major contributors was Robert Mercer, a successful hedge fund manager. HIs daughter, Rebekah contributed almost $4 million and now serves on his transition committee. Of note is that Mr. Mercer is a hawk on monetary policy and funded efforts to resurrect the gold standard. Some members of Mr. Trump's cabinet are also looking at re-establishing the gold standard. For Mercer and other Republicans, the Fed has grown too large and the creators of money needed to be reined in. To be sure, a reversion to the gold standard would remove the printing power from the Fed and is the hidden beauty of a better policy alternative than maintaining the current artificial environment. Mike Pence, Vice President-elect too supported the rethink of the role of gold in international markets. On Trump's advisory team there are other pro-gold proponents including Judy Shelton co-director of the sound money project who advocated gold backed bonds and Lawrence Kudlow recently appointed to head the White House Council of economic Affairs. We believe hard money enthusiasts account for nearly 30 percent of Trump's team.
China has the Gold
Consequently, using gold as collateral for sovereign debt would alleviate the pressures of Mr. Trump's ambitious agenda. America has more gold than the IMF and Germany combined and gold backed loans would also lower sovereign debt yields without increasing inflation. America could use a portion of their gold reserves in this way. However, as Trump feared earlier, the United States does not have enough gold and too much debt. In fact, China has the gold. Asian central banks and the public have been buying gold because they have more dollars than they want, and not enough gold. China has reported gold reserves at 1,833 tonnes up from 600 tonnes in 2003. The largest sixteen commercial banks in China hold on behalf of their clients, including the government some 2,500 tonnes, according to published reports. Chinese jewellery demand and "grannie" purchases are believed to part of the estimated 2,000 tonnes withdrawn this year from the Shanghai Gold Exchange (SGE). Gold is a rational central banker's solution to excess dollars and hedge against devaluation. China and Japan are the world's largest creditors and America has accumulated the world's largest debt at $20 trillion. Both governments eye the situation with trepidation. The Chinese fear a collapse in the purchasing power of their Treasury hoard and America, a collapse in the funding of their debt.
Today the rise of China, America's largest trading partner is challenging American dollar hegemony. China has set up swaps around the world in an effort to make its currency convertible. China's renminbi is now a reserve currency as part of the International Monetary Fund's SDR basket. Also China continues to innovate its financial markets, becoming the world's largest gold trader. China is the world's largest consumer and largest producer of gold. The sinking renminbi has resulted in strong demand for physical gold. China has been also buying gold to hedge their massive $3 trillion of foreign exchange reserves consisting largely of US debt, joining other central banks led by Russia which has been buying gold for 21 months in a row.
Established in 2002, the Shanghai Gold Exchange is wholly owned by the Chinese government and has become the world's largest bullion trader. Lately premiums have been as high as 25 percent above spot reflecting growing demand and tight supplies. With a network of 55 vaults, gold withdrawals from SGE are expected to reach a whopping 2,000 tonnes this year Since the Shanghai Gold Exchange introduced twice daily renminbi per gram benchmark in April, we estimate that gold has traded at a premium to Comex gold more than 60 percent of the time. Gold has retained much of its value and in the past was widely used as gifts during the wedding season. However today, gold has become an effective monetary hedge, particularly when more than a third of global sovereign debt yields less than zero percent.
Gold, an Investment in Monetary Disorder
The dilemma is that US reserves of gold are relatively small to its monetary base, thus a price over $10,000 an ounce would be needed to reintroduce a gold standard (a far cry from $32 an ounce). While the adoption of a gold standard is unthinkable, so was Mr. Trump's election. While we would not bet on a gold standard returning soon, America's deficits will not disappear unless they renege or debase the dollar further. If not, America will continue to print money, either for Trumponomics or to stave off default. The fear of widespread currency debasement and the consequential inflation could create the condition for another run. After all, the animal spirits are back. We would bet then that the potential for a golden solution is in sight and that the current gold price is not too far away from a bottom, particularly when so much fear stalks the world. We thus remain bullish on gold believing that it will reach $2,200 an ounce within 18 months.
Gold mining shares have weakened due to the lower bullion price just after recording a profitable third quarter. The earlier gold bounce allowed some companies to repair balance sheets. Others led by Barrick sold non-core assets, reduced overheads and scaled back exploration in order to become more profitable instead of growing ounces. Most miners repaired their balance sheets with equity issues. Of course with the cutback in exploration, there were fewer major discoveries. Currently there is a shortage of large-scale discoveries and although exploration is the lifeblood for the mining industry, M+A activity seems the policy du jour. Last year of a dozen companies, only two increased their reserves so miners must either acquire assets or explore. Recently Kirkland Lake and Newmarket merged since it was cheaper for them to merge than to explore for greenfield ounces. The Chinese companies have been aggressive acquiring assets and a few are bidding for Barrick's 50 percent stake in Kalgoorlie, the largest gold mine in Australia.
With a focus on net free cash flow, investors have returned. However, there is a need for some to show growth. We like Barrick for its improving balance sheet and the fact that it has 90 million ounces of in situ reserves. Agnico Eagle and B2Gold are favoured for their growth pipelines with Eldorado a turnaround situation after 17 year veteran Paul Wright retires. Eldorado is developing projects in Greece, building Skouries and Olympias Phase 2 which will be a major contributor to earnings. As far as big new discoveries, there have not been any new ones, other than Pretium which is coming on stream over the next year.
Agnico Eagle Mines
With eight operating mines in Canada, Finland and Mexico, Agnico should produce 1.6 million ounces at AISC of $890 per ounce. Agnico's existing asset base has potential to produce 2 million ounces in 2002. Agnico continues to execute in geographic safe jurisdictions causing it to trade at a premium to its peers. In the latest quarter the company reduced debt and Meliadine in Nunavut is fully permitted will produce 325,000 ounces annually by 2020, after a capex of almost $1 billion. Agnico has a strong exploration team and a portfolio of prospects in mining friendly jurisdictions. Agnico has almost 20 million ounces of in situ gold reserves. We like the shares here.
B2Gold has four operating mines, La Libertad and Limon in Nicaragua, Masbate in the Philippines and Otjikoto in Namibia. A fifth, Fekola is on schedule to come into production next year at an all in cost closer to $800. Fekola in southwestern Mali is a large open pit and will cost about almost half billion dollars to put into production. In 2018, B2Gold could be producing 900,000 to 950,000 ounces. We like B2Gold here for its growth in production and reserves.
Barrick Gold Corp.
Barrick Gold continues to focus on debt reduction with net debt at $6 billion, down from a peak of almost $16 billion in 2003. Barrick today has strong net free cash flow and could reduce debt further through the sale of 64 percent Acacia Mining in Tanzania or Lumwana copper in Zambia or 50 percent owned stake in Kalgoorlie which could net $1 billion. The company is focused on organic growth and will easily achieve their $2 billion target of debt reduction this year. Still, Barrick continues to upgrade its portfolio and has sought partnership deals with Pascua Lama a likely candidate. Proforma without Acacia and Kalgoorlie Barrick will produce 4 to 4.5 million ounces. Buy.
Eldorado Gold Corp.
Eldorado closed its $900 million Chinese asset sales and so the company has a healthy balance sheet. Eldorado is expected to grow production from 400,000 ounces at $850 AISC to 800,000 ounces at $650 AISC by 2020 due to its Greek projects. Work continues at Skouries and Olympia, with Olympia Phase II slated to contribute early next year. We like the shares down here.
Goldcorp's results were aided by a strong improvement from the Pueblo Viejo joint venture which offset disappointments at Eleanore in Quebec which is still in ramp up mode. Goldcorp is at long last pruning its portfolio, selling non-core Los Filos in Mexico which might generate about $200 million and Camino Rojo also in Mexico which might generate another $200 million. Guatemala (Marlin) is also slated for sale. As the Company seeks to boost production and reduce costs, flagship Penasquito is running out of ore so the pyrite leach project which will cost almost a half a billion won't be contributing until 2019 the earliest. We believe Goldcorp still needs to rationalize their assets with a need to turnaround Penasquito, Musselwhite and fix their Ontario strategy. We prefer Barrick here.
Kinross Gold Corp.
Kinross maintains a strong balance sheet which allows it the time to turn the company around. No debt matures until 2020. Tasiast in Mauritania remains a sinkhole for costs and so the balance sheet is useful while they complete Phase I. Kinross repaid $250 million senior notes. Recently acquired Bald Mountain and the other half of Round Mountain in Nevada are slated for expansion, with the task to extend both mine's mine lives. Kinross now has 60 percent of production located in the Americas, reducing exposure to Russia. We prefer Agnico-Eagle here.
Yamana Gold Inc.
Yamana successfully spun off Brio Gold although it received less than anticipated. Nonetheless the sale helps the company reduce debt with net debt at more than $1.5 billion. Yamana's leveraged balance sheet overhangs the near term outlook. Yamana has Chapada, El Penon in Chile, 50 percent stake in Canadian Malartic and Jacobina. Yamana has to pay about $100 million over the next 12 months which should be handled by cash flow and credit facilities. Development at Cerro Moro in Argentina continues and production is scheduled for the first part of 2017. We prefer Eldorado Gold.
Rating: 5 - Strong Buy 4 - Buy 3 - Hold 2 - Sell 1 -Strong Sell
|Company Name||Trading Symbol||*Exchange||Disclosure code||Rating|
|Barrick Gold Corp.||ABX||T||1||5|