The economic elite exemplified by the Davos participants have done much to undermine their credibility, suffering from the backlash for cheerleading the governments' experimental monetary programmes of quantitative easing, to negative interest rates and of course globalisation which neither lifted the world economies nor provided the promised jobs. Weathermen had a better batting percentage. To be sure the rich got richer and the poor, poorer providing the fodder for President Trump's victory. Already chastened for failing to predict the 2008 crash and Trump's election, they have again misread the tea leaves.
It is a mistake to dismiss Trump's missives or tweets as random missteps which Clinton and Trump's Republican opponents made consistently. Trump in hindsight was simply posturing, sometimes testing the waters and sometimes obscuring his message, leaving him to negotiate on his terms rather than his opponents'. To be sure governments, pundits and the populace should be prepared for his "bully pulpit" and not the literal message itself. Investors would be wise to take a deep Pranayama (yoga) breath.
The New Year has brought increased volatility with the low interest rate environment fading away replaced by the politics of rage, a hard Brexit and, the Trump trade. But beneath the veneer of Trump optimism lurks high anxiety about a toxic, divided nation and deepening global concerns over multi-lateral trade wars with Europe, Middle East and China. The root causes of the Trump trade are much deeper and, underlying the lofty market optimism are wider deficits, more government intervention and an increase in protectionist measures.
Buy On Mystery, Sell on History
In a classic "buy on mystery, sell on history", we believe Trump's inauguration will turn the "Trump bump into the Trump dump". Investors are anxiously anticipating Trump tax cuts and business friendly policies to spur Trump growth and ultimately more inflation. However, the market has yet to figure out the consequences of this path to growth, particularly when debt is so high. The Federal Reserve has already changed tack with the second of many interest rate increases to come.
Risks abound. Yet spreads in the bond market have not reflected these risks. Key European elections are scheduled this year. China may or may not be in the midst of a currency war that no one wins and the US dollar strength, while illusory has exacerbated the problems in Europe and Mexico. Brexit festers away. And the solutions? Not from the economic elite, to be sure. Nor from the media elite. Voters are right to sense that the answers are not to be found in the old familiar places.
In the eurozone, Italy recently nationalized the world's oldest bank, Monte de Pesci, with a bail out by Italy's Resolution Fund which contravened the EU's edicts and was conveniently overlooked by the regulators. One of the reasons is that Wall Street's exposure to the EU is a reported $2 trillion exposure and roughly half of that exposure are off balance sheet items according to the US independent financial monitoring unit, the Office of Financial Research (OFR). And, despite promises of, "doing whatever it takes", the European Central Bank (ECB) is close to the legal constraints on the amount of bonds it can buy. Then there is the two-year experiment of "pump and dump" oil markets ending when OPEC, hurt by lower prices and exploding deficits, reset the first production cut in about 13 years to raise prices, difficult since non-OPEC producers have replaced Saudi Arabia as the swing producer. Still prices have risen 25 percent since the agreement and oil is back from the dead. Investors should therefore not be in much doubt. Elevated risks and uncertainity lies ahead. To the market this is unwelcome. Clearly, though it is the reality.
Mr. Trump's "Art of the Deal"
Mr. Trump's complaint about America is really a structural problem. Governments over the past eight years doubled down on deficit spending, money printing and regulations, to revive their economies but those attempts haven't worked. The American economy is chronically sick. Costs are too high, making exports uncompetitive so that America has become more of a service economy with improvements in productivity difficult to achieve.
Mr. Trump inherits a divided country, some no doubt of his own making but much due to his predecessor. Mr. Obama has been a major disappointment at home and abroad and despite the hope, rhetoric and trillions of debt, America remains stuck in a subpar recovery. Promises of income redistribution, favoured the wealthy, not the poor. His foreign policy was a disaster with this Noble Prize winner at war longer than any other American president, longer than Johnson, Lincoln and George W. Bush. In fact, some of those wars were conducted without congressional approval, an act in itself unconstitutional. Race relations are worse and, his party paid a heavy price, losing not only the White House but the House of Representatives and the Senate.
One could argue that President Trump will shake things up and in rejecting the status quo and longstanding norms both domestically and internationally, his world order would appear to trump the postwar blueprint that hugely benefitted the United States. In serving American interests, disputes were generally handled with a mutually of interest or common ground. While Trump's appeal is the chaos that he threatens to bring, that chaos in the form of a protectionist trade agenda could only undermine America's geopolitical influence, particularly at a time when America's ability to remain the world's most powerful economy is weakened by a balance sheet in shambles. And the long standing network of alliances, once dependant upon on trade, trust and pocketbook issues is now threatened. Trump's threats are as important as money, and bullying allies or trading partners won't be as easy as terrorizing Washington's mandarins or auto companies.
America's Debt is Its Achilles Heel
While Trump's ambitious fiscal plans will entail a big expansion of the budget deficit, that deficit will require financing and the "king of debt" will certainly launch another round of debt which will unnerve the market. However, we believe Trump's team will seek alternatives such as extensions of longer dated securities or even, gold backed debt or other exotic securities. Where Trump has made points is that there is too much regulation. It was hard to achieve the economies of scale sometimes because of the increased regulatory tightening. Mr. Trump has sworn to take a wrecking ball to regulatory policy and will undo much of Obama's legacy on everything from the 2,700 page ObamaCare to his nuclear deal with Iran to the Paris climate change accord using the same Executive Orders that Mr. Obama used to circumvent Congress. What can be done by the pen, will be undone by the pen.
Yet, America has been running deficits for years flooding the world with cheap dollars. The Fed has yet to unwind its swollen crisis-era balance sheet of bonds and mortgage-backed securities. Financial leverage today is much higher than 2008 and the systemic risk is greater. Instead of subprime mortgages, we have subprime auto debt for example. US treasury debt issuance doubled in size over the last eight years. Until recently there was no problem for America to finance the deficits with foreign money. In the first nine months of 2016, foreigners purchased almost $3 billion every day. However, foreign appetite has been waning and the dependence upon the largesse of foreigners is America's Achilles heel.
In addition, foreigners have adopted a more cautious wait-and-see attitude with respect to Mr. Trump's policies. Should Trump decide to clash with America's trading partners, they might not be so willing to finance "America First" agenda of tariff barriers and competitive devaluations. The very real prospect of a currency war where both sides seek a trade advantage has forced each country to focus on their domestic economies and to look for alternatives.
Russia and China's Plan B
A global stampede into US assets pushed the Trump dollar to near 14 year highs, but swiftly corrected on Trump's musings and weakening economic fundamentals. Mr. Trump's musings about the strong value of the dollar, raised fears that his presidency could set off a new round of currency wars in a "beggar thy neighbour" fight that could set the ground for a broader trade war. In the Middle East, the Saudis have run a fiscal deficit of almost 10 percent of GDP. To fund their deficits, the Saudis and other Gulf countries have been selling their reserves, dumping US treasuries. China too has sold $150 billion of US treasuries to support the renminbi, dipping into its $3 trillion stockpile. Still, China's reserves are twice its foreign debt. Russia also has been selling US assets. Since July 2014, China has seen a near $1 trillion dip in their reserves as they also bought euros as a means to finance recent acquisitions and prop up the renminbi. Today, US interest rates are above those in the euro area which remain negative with the European Central Bank (ECB) and Bank of Japan both setting their benchmark rates below zero, continuing to print money with no end in sight.
During the Dirty Thirties, rounds and rounds of competitive devaluations and trade barriers in a "beggar thy neighbour" policy gave rise to the disastrous Smoot-Hawley legislation which led to the Depression. A new trade war is in no nation's interest, particularly America. Not only is a tariff for tariff war expensive but risks spreading where no one wins. While fundamentally a lower renminbi would help Chinese exports, it certainly would widen the trade deficit with America at a time when both countries are each other's major trading partner. China's depreciating renminbi has also impacted its neighbors, giving the renminbi an added export advantage. Post election US trade policies under Trump's presidency will be key. So far the rhetoric and threats may just be Trump's way of an opening bid ahead of negotiations, but risks of an escalation have increased significantly and the critical variable will be the dollar. Currencies, commodity levels and legislation will be top of mind as the US dollar's share of currency reserves slipped to 63 percent last year, according to the International Monetary Fund (IMF).
A Return to a Gold Standard?
Today, China and others have their currencies pegged to the dollar and its strength is hurting their economies leading to talk of a return to protectionist barriers. With a debt load at 100 percent of gross domestic product (GDP), America's balance sheet is in shambles. They not only have massive debts but are still running big deficits. At $20 trillion, nearly half of that debt is owed to foreigners. The United States is the world's most privileged nation, with the privilege of paying their bills in a currency it prints, allowing them to consume more than they produce. Significantly, that privilege rests on the confidence of its creditors but lately that confidence has been frayed.
Mr. Trump's ambitious policies are clear, but it will cost money. America has very little savings and so their deficits are set to grow again. The stock market? It is built on sand and higher rates to attract foreign dollars will be needed which will remove yet another prop under the overvalued market. Looks deceive. Today America's trading partners are pursuing a Plan B. Exporters of oil are taking euros, renminbi or yen for their oil. China has become less dollar dependant and central banks are adding to stockpiles of gold leftover as legacy assets from prior gold-backed currency regimes. We believe China could make the renminbi backed by gold. After all, one time its currency was backed by silver.
For the past two years, China and Russia have been adding to their gold reserves reducing their dependence on the dollar. China has become the sixth largest holder in the world at 1,833 tonnes but is only 2 percent of reserves in contrast to the 10 percent average held by most western central banks. Yet China's total holding is much larger since they have been adding to their gold hoard both officially and unofficially. It has been reported that Chinese banks hold some 2,000 tonnes for their customers and last year over 1,200 tonnes were withdrawn from the Shanghai Gold Exchange (SGE). China is the world's largest producer and consumer of gold in the world. We believe that itsmassive $3 trillion hoard of foreign exchange is slowly being invested in gold which is denominated in dollars, but does not have the purchasing power risk of US treasuries. Russia too has accumulated 1,542 tonnes ranking seventh in the world. In total, Russia and China hold more gold than the United States, the world's largest holder at 8,134 tonnes. Mr. Trump would be wise to remember the golden rule when he next threatens these two from his bully pulpit.
Gold Is Money
Lastly, desperate for revenues, countries have declared a war on "private savings". In the West, closure of tax havens, targeting offshore companies and even negative interest rates have confiscated savings. Some countries like Greece, Venezuela and even Iceland are experimenting with capital controls because of their need for revenues as an alternative to debasing their debts. China too recently introduced restrictions on forex outflows to slowdown the renminbi's depreciation. Iceland imposed capital controls to protect the krona, but soon imports became too expensive causing Iceland's foreign debtholders to be concerned about the repayment of Iceland's debt.
And then, taking aim at savers. India demonetized its high-value bank notes, targeting the cash-driven black market. The cash-cancelling move caused chaos in the Indian banking system with lineups frustrating everyone since more than 86 percent of the cash in circulation became worthless overnight. Nearly 80 percent of India's consumer activity is in cash and while the country's tax base is only 10 percent of the economy, cheap loans were offered to stimulate India's $2 trillion GDP which collapsed because of the money grab. Embarrassingly with nine-tenths of cancelled notes returned there was neither an increase in economic activity nor a rush in government revenues. Car sales actually fell 19 percent. Notable was that short term imports fell after the demonetization but gold ownership actually increased. Ironically, Indian refiner incentives introduced gold ownership as tender – a defacto Indian gold standard. Venezuela, followed India's example by demonetizing nearly half of that country's bank notes to fight the black market, hurting its people who are suffering from hyperinflation, cash shortages and an economic meltdown. Gold of course skyrocketed. In the Middle East, the new Shari'ah gold investment standard will encourage gold purchases. Money is no longer money Gold is a protector from this war on savings.
As a result, gold is back in demand amid increasing concerns over the health of the global economy and doubts that Trump can make America great again. The belief that there is a worldwide war on savings, geopolitical and trade concerns has caused money to chase gold. Mr. Trump does not seem to be bothered by debt. America's deficits are unsustainable. The deficit has risen to the point where the US must borrow $150 billion every day. We are concerned that foreign investors may go on strike because they already have too many dollars and he may give them a reason to pursue Plan B.
The problem is not new. After eight years, we continue to warn about America's vulnerability. America's debt load is unsustainable. The world has too many dollars. America does not have a Plan B. Gold is a barometer of currency fears. If investors believe that the dollar is an overvalued currency, and also lack the confidence in other currencies, gold is a natural haven. Without confidence in the dollar, the world has no valid reserve currency. If confidence is not restored, the pressure will be to pursue tried and unsuccessful measures like competitive devaluations, protectionism or again, money printing. Both the dollar and gold are telling us that an adjustment lies ahead. Gold is a good thing to have. We continue to believe, once it breaks above $1,250 an ounce, that gold's new bull run will reach $2,200 an ounce – a perfect Plan B.
Gold peaked in 2011 and recently recorded a partial recovery, leading in our view to the resumption of its 12 year bull market. The industry, after writing off tens of billions of dollars during the first bull run, are poised to make money again. Miners last year recorded topsy-turvy results. While most reported net free cash flow, some had difficulty making money even with a higher gold price. As a result there was the usual M&A activity with the spinning off of non-core assets in order to reduce costs, focusing more on core assets. Newmont sold Batu Hijau ridding themselves of a geographic risk problem. Eldorado sold its Chinese assets. Goldcorp. on the other hand purchased Kaminak's Coffee project in the Yukon adding to its inventory portfolio. That deal is strange given the fact that Goldcorp. already has a number of inventory type assets. Nonetheless the focus is on replacing reserves because in 2015, only two of the majors replaced their reserves.
Meantime a few development prospects are emerging as future targets. Continental Gold finally received a major permit paving the way for financing to advance its Buritica gold/silver project in Columbia. Currently Continental has conducted a major exploration program to augment its feasibility study which calls for a 3,200 tpd plant and annual production of 250,000 ounces of gold. Rye Patch Gold will bring into production, former producer Florida Canyon early this year, at to about 50,000 ounces annually for the next eight years. TMAC Resources will produce 130,000 ounces at Hope Bay in Nunavut this year. Notable however is that these developments will not replace reserves and thus the likelihood for more M&A activity in an industry consolidation.
Agnico Eagle Mines
Agnico Eagle reported positive free cash flow in the third quarter on production of 416,000 ounces at an all in cost of $820 per ounce. Record production at La India and silver output from the Mexican operations helped results. In addition, Agnico Eagle's joint venture Canadian Malartic Mine in Québec contributed about 76,000 ounces to Agnico Eagle's book. La India contributed about 30,000 ounces and high grade Lapa also recorded a strong quarter. To be sure, Agnico Eagle's Mexican southern business core group has developed along with its flagship La Ronde in Quebec. The next core area of course is the development at Amaruq and Meliadine which will extend the life ofMeadowbank in Nunavut. Agnico Eagle will release an updated resource shortly. Agnico has a strong balance sheet with cash and short term investments of $627 million against net debt of $588 million plus an untouched $1.2 billion credit facility. Also, Agnico for some time has made investments in a number of smaller exploration/development situations. This "skunk works" approach is now being emulated by other producers as a means to better exploit resources. We like the shares here.
Intermediate gold producer, B2Gold reported record gold production of about 145,000 ounces up 18 percent in the last quarter. B2Gold has four producing gold mines and Fekola in Mali will be commissioned this year at 350,000 ounces at a cash cost of $420 an ounce in its first full year of production. The open pit mine is similar to recently commissioned Otjikoto in Namibia and is fully funded. B2Gold has one of the best growth profiles in production and reserves and we like the shares here, trading at a discount to NAV.
Eldorado Gold Corporation
Eldorado reported a drop in gold production this year to 485,000 ounces largely due to the sale of their Chinese assets and slippage at flagship Kisladag in Turkey. With total liquidity of about $1.1 billion (including $880 million in cash), the loss of ounces from the sale of Chinese assets was expected but unexpected was the shelving of the Kisladag expansion in order to save $100 million. The reports are surprising given Eldorado's solid balance sheet and their need to replace the Chinese reserves and production. Meantime Olympias Phase II in Greece is set for commissioning and Skouries construction is expected to continue with a target date in 2020. Of note is that Eldorado will be shy of the 400,000 ounce production target this year and while the company reduced costs, we believe there is probably more bad news to come. Also unexpected is the "retirement" of Paul Wright. Eldorado shares are cheap but at current levels we prefer B2Gold.
Taking a page from Barrick's book, Goldcorp has unloaded non-core assets Los Filos in Mexico for a reported $438 million. Also, Goldcorp sold Cerro Blanco gold/silver project in Guatemala. The sales are part of a renewed focus on core assets. Goldcorp shares have underperformed due to operational and earnings disappointments and the need to replace declining reserves at flagships Red Lake and Penasquito. Although the Company has articulated a long term strategy, near term there is little on the horizon. Eleonore and Cerro Negro still need to operate at project design capacity. And recent acquisitions such as Coffee as well as an Ontario strategy (Cochenour and Young projects) are in need of a strategy. Goldcorp produced 2,900,000 ounces in 2016 but output will slip to 2,500,000 ounces after sale of Los Filos and the closure of Marlin. We prefer Barrick here.
McEwen Mining Inc.
McEwen Mining produced 145,000 gold equivalent ounces from its Mexican El Gallo flagship and a contribution from 49 percent owned San Jose mine in Argentina. At yearend McEwen had no debt and doubled its liquidity at $64 million, including $21 million in precious metals. McEwen's cash flow, balance sheet and management team allow it to become an acquisitor in todays market. We like the shares here.
Newmont Mining Corp.
Newmont successfully brought Long Canyon in Nevada into production ahead of schedule and under budget. Long Canyon cost $225 million and should produce 125,000 ounces a year over an eight year mine life. Importantly all in cost should be below $600 an ounce. Long Canyon is an oxide gold deposit with a resource of 3.4 million ounces. Newmont generated free cash flow in the latest quarter and while the stock is cheap, it too is plagued with a flat production profile. While the handwaving over Long Canyon is positive, needed is a company builder. We prefer Barrick here.
Yamana Gold Inc.
Canadian producer Yamana spun off Brio Gold through a rights issue after earlier attempts were unsuccessful. While Yamana wanted to sell more than 50 percent, only 15 percent was sold. Brio Gold contains three of Yamana's non-core assets such as Fazenda Brasileiro and Pilar gold mine plus Santa Luiz which could reopen in 2018. Yamana purchased Riacho dos Machados (RDM) which added ounces but was financed with debt to dress up Brio. Brio is a high cost entity ($1,000 AISC) and has a credit facility about $75 million, needed because cash is less than $6 million. Yamana was obviously disappointed in netting only $50 million dollars and Yamana still is in need of improving its stable of assets. However, debt stands at $1.5 billion.Meantime, flagship El Penon in Chile which faces a short reserve life was hit with a short labour shutdown by its underground mine workers. Cerro Morro remains on track and is slated for production in 2018, however, guidance for 2017 is still up in the air. We would avoid the shares here.
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|