Gold: Mr. Trump Goes To Washington

After the Trump tsunami, predictions including our own were fortunately relegated to the dustbin of history. While visiting Hong Kong, we watched Trump’s victory with gold skyrocketing over $30 and the market meltdown was some 800 points. However, the next morning, gold was off $30 and not the $100 an ounce spike we expected, with the market closing up 300 points.

Everyone hates uncertainty and the Donald’s success as President raised fears of a black hole as the glass that was half full, is now half empty. Rather like his victory, investors saw what they wanted. His presidential demeanor made the President-elect look, more presidential – he must be president then.  Near term, the outcome outweighed the uncertainties. However, the realities of political deal-making and his inevitable fence mending will likely leave investors in the dark for some time.

The Republicans will control the White House and both chambers of Congress. Of course, there is no certainty that the Republicans will support their leader. After all, they did not support him during the election. Bad blood between the two parties is only surmounted by bad blood within their parties. America is divided. To be sure important problems such as the tax code, America’s record debt, infrastructure requirements or even immigration needs fixing. But Mr. Trump is caught in a vicious circle where he will cut taxes and red tape with a focus on domestic issues which will result in higher interest rates, trade tariffs and higher inflation.

The President-elect’s victory was one of the biggest upsets in modern US history, shocking America’s power structure, popular media, Wall Street and just about everybody else, but Main Street. Who knew those so called deplorables would number more than 60 million of Americans? Trump did. Britain’s vote to leave the European Union and Trump’s victory has fueled concerns that populism is gaining, at the expense of the status quo. The upcoming December 4^th Italian constitutional referendum and elections in France and Germany next year are yet another test that could pave the path for another euro exit. In the wake of Trump’s victory, the shifting geopolitical balance will impact globalization, immigration and the establishment, all targets of Mr. Trump.

So many words are wasted on what Trump will or won’t do. The media, Democrats, world leaders and even his own party who were against his election are now giving unsolicited advice on what he should or not do and some even suggest he abandon his freestyling ways that upset the well entrenched and financed political elite. To be sure, Mr. Trump’s every move and tweet will be magnified. The media narrative, as usual has taken a literal view of his previous pronouncements comparing them against recent announcements in a “gotchya” attempt. In essence there are two Trumps, the candidate versus the president. Campaign rhetoric is one thing, the president is another. Which one will surface?

The Apprentice In Waiting

A perfect example is the fear or hype of a full-blown trade war with America’s biggest creditor China, on concerns of a new era of US protectionism. We believe a more practical approach is likely because China is the largest trading partner of the United States. While Mr. Trump threatened to slap a whopping 45 percent tariff on Chinese imports and name the country as a currency manipulator, a fight would boost consumer prices hurting his mainstream constituency in the pocketbook. More relevant is that China's $1.3 trillion of US Treasuries could be unloaded pretty quickly, sending interest rates higher which would have a much more negative consequence on the domestic economy. Besides, it seems that every president before him has threatened to impose trade barriers and the most recent, Mr. Obama actually imposed a tariff on Chinese tires which was quickly dismantled when China, in a tit-for-tat move, put its own tariff on US car parts and chicken. This time Apple phones, Boeing airliners and Hollywood movies are in China’s arsenal.

Trump’s tearing up of the TPP, Brexit and the Belgium hold up of the Canada-EU Pact are part of the slippery slope of protectionism, reminiscent of the Dirty Thirties and the Smoot-Hawley Tariff Act which seized up trade in the Thirties and of course contributed to the Great Depression. Competitive devaluation is one barrier to trade. Tariffs, of course are another. Tariffs still protect Canada’s milk producers for example. The essence of the trade deals is not the loss of jobs but the free flow of goods and services at much lower prices. Tariffs simply subsidize jobs. Today, Canada, Europe, China and the US are reliant on trade. China remains the American’s major trading partner but 80 percent of Canadian exports go to the United States. What our populist leaders will soon discover that by erecting trade barriers, as in the Thirties, they might protect some jobs but those US working class families won’t be able to afford their cars, vacuum cleaners, Walmart or Apple products. And that is something even Trump can understand.

Simply everyone must take a deep breath and relax. A new day has come and who knows, Mr. Trump might well make a decent president. We believe that China and the United States could  actually be facing a new era of cooperation with shared responsibilities for stability in the world.  To be sure, over the next few years, Mr. Xi and Mr.Trump will have numerous opportunities for both strongmen to get to know each other. After all it took Nixon, that other Republican, to normalize relations with China, which changed the world. The good news is that this non-politician president could act in a business-like manner – he has a transactional mindset, whether it is positive remains to be seen. The bad news, is that no one can tell this apprentice, he is fired.

Yet there were losers. The Mexican peso is off more than 10 percent. US Treasuries took their biggest plunge in five years on fears that Trump will ramp up spending to revive the economy. Other losers were the interest rate sensitive stocks. Gold futures were also losers as gold fell to six month lows on fears of a Yellen interest rate increase in December. Ironically by reviving growth, inflation will pick up as well which will be good for gold.  We believe there is still much uncertainty and the lack of clarity on the policies of the new administration plus the Italian vote in December will keep investors cautious. And while the promised tax cuts plus $1 trillion of spending will be enough to revive the economy, Mr. Trump’s debt binge could go bust.

Global bond markets swooned while the greenback strengthened to 13 year highs as investors bet that Mr. Trump will unveil an inflation fuelling economic stimulus package of tax cuts and infrastructure spending. Instead of unconventional central bank monetary policy, it will be replaced by a massive printing exercise that monetizes Treasuries at a time when its creditors are dumping Treasuries. Obviously bonds are in bubble territory and the valuations of equities are rich but noteworthy is that global debt continues to rise from the 2008 crisis, to levels never witnessed before. With higher rates, the cost of debt will rise. Also with Mr. Trump likely to remove the thousands of pages of complex financial regulation and by unwittingly dismantling the nanny state coddling of the banking system, he could leave it exposed for failure. In the past, government rescue plans benefitted a handful of Wall Street firms at the expense of society. This time it may be different.  

Inflation Is Back

We also believe inflation is more likely. In 2008, central banks experimented with everything from quantitative easing to negative interest rates with debt increasing to record levels, which fuelled asset bubbles abroad and at home. Historically, inflation is a product of too much money chasing too few goods. Deflation on the other hand is a symptom of too little money but this time, thanks to the central banks, we have too much money. To be sure, producer prices appear to be edging up as the excess capacity built up in anticipation of a Chinese supercycle finally was extinguished. Oil at $50 a barrel, cheap by the standards of the past decades is still higher than the lows of January. The recent increase occurred not because of OPEC jawboning but because excess capacity was shutdown, finally meeting demand. Similarly, the shutdown of excess coal and steel capacity has resulted in a resurgence of prices. It is clear that with prices stabilizing, the next step is a ratcheting up, as demand increases.

We are at a second inflection point as we move from a deflationary era to a reflationary era. Mr. Trump’s victory will ensure a revival in prices. Eventually, the normal economic rules will prevail and the past extraordinary measures by the central banks, which resulted in an excess supply of dollars will erode the attraction of American money. In the UK too, the likelihood of a sharp rise in inflation is substantial given the plunge in sterling to all-time lows. Britain also faces a £100 billion Brexit budget hole. Exchange rates have become volatile feeding the embers of inflation. We believe this toxic combination of depreciating currencies will catch policymakers unaware. Inflation is back.

Land Of Silk And Money

China’s One Belt, One Road project is the largest infrastructure plan in the world, linking over 65 countries along transportation corridors that follow the path of the ancient Silk Road which stretched from China through Central Asia into Europe. While much of the plan is not yet spelled out, Chinese banks and the newly formed Chinese AIIB infrastructure bank are expected to finance a major part of the route. China has thirty agreements with countries along the route with more to follow. Energy investments in Russia and Central Asia will see pipelines carry the energy into China. The plan emulates the Marshall Plan which was an American initiative to help rebuild the European economies after the war, using America’s spare industrial capacity. The Marshall Plan also entrenched the US dollar in the world’s global architecture which of course benefitted American businesses. The investment in the One Belt, One Road is expected to reach $3 trillion, overshadowing the post World War II Marshall Plan which cost roughly $13 billion.

President Xi Jinpeng has shifted the Chinese economy more towards consumer spending but still capital investment remains key. China ascent to superpower status was driven by a state capitalism system. His One Belt, One Road is expected be a major contributor to businesses, enabling goods and resources to travel from Europe to China on land and sea, financed by the renminbi, making the renminbi more of a convertible currency. 

In China, the Singles’ Day shopping extravaganza falls on November 11 that resembles four sticks, and in Chinese, the word for bachelors. November 11 is not a recorded holiday nor does it represent any religious or political association but in China, thanks to Alibaba, it is a celebration of singlehood and consumerism. Alibaba has turned the day into 24 hours of frenzied online shopping that encourages consumerism and this year surpassed $17 billion of gross merchandising value. Online sales made up almost 12 percent of China's total sales in the first nine months of this year. Of course the use of smart phones has resulted in an increase in spending. Of interest is that the courier business delivered an estimated billion packages. China’s economy is alive.

Make Gold Great Again

Uncertainty in Mr. Trump’s book, is a strength. In making America Great Again, there are also downsides. Mr. Trump threatens to undo America’s hegemony and dismantle the global architecture that saw US national interests embedded in the international economic and financial system. It is expected that while Trump is preoccupied with domestic issues, China will fill the void moving the axis in the now-stalled 12 nation Trans Pacific Partnership (TPP) which accounts for 40 percent of the world economy, from the United States to China. TPP was to be about the US showing leadership in the regime. Backing away will help accelerate the decline of US influence. Already America’s global power is threatened by China and other rising states, like Persian states demanding a stronger voice in managing the international financial system. China is set to assume leadership in this new monetary order.

There is no question that debt has skyrocketed just about everywhere else. The IMF calculates world debt at 225 percent of gross domestic product including combined public and private debt. To be sure debtors have benefited from ultralow interest rates and in fact there is an inducement to borrow even more. However, should interest rates edge up as they inevitably will, debtors will lose the ability to repay. One of Mr. Trump’s biggest problem is money. The United States is $20 trillion in debt and large deficits will be the norm.  We believe questions will arise about the United State’s fiscal sustainability, particularly given Trump’s stimulus plans, usage of debt and offhanded comments about renegotiating America’s debt.  The dollar’s strength is transitory.

We believe Trump’s election is an inflection point and the dollar, once considered a haven, is vulnerable. In the Forties, the British pound was the haven currency because of Britain’s balance sheet, military might and strong alliances. However, the cost of war saw the US replace Britain as the world’s superpower with the dollar replacing the pound. In a déjà vu moment, America’s record debt is set to grow, her alliances are threatened and a protectionist stance could push its creditors who have now the power to topple the dollar’s reserve status. Gold would be a good thing to have then.

Central Banks, Creators and Controllers

For years, we have warned about fiat money, particularly after almost a decade of unconventional monetary policies. We believe the era of paper money and its loss of value is finally coming to an end as well as the tenure of their alchemists, the central banks. Their role is under review. Markets have become distorted by the flood of paper currencies created by the central bankers in their war on savers, hoping to get them to spend. Negative rates was the latest move, but now India has demonetised their existing 500 and 1,000 rupees currency notes (valued at $7.50 and $15.00 respectively) causing a spike in gold purchases. These notes make up about 85 percent of India’s total currency supply and were deemed worthless to eliminate the black market and the hoarding of cash. Such a shock treatment has been seen before in Germany, the Soviet Union and recently Zimbabwe. The currency crunch and confiscation of wealth in India is a symptom of money not being money and a war on savers. Then there is Sweden’s Riksbank, the world’s oldest central bank, considering moving away from cash to a digital currency. Central banks are part of the problem. They were once stewards of money but having created money, now want to control money.  

“The dollar is our currency, but it’s your problem”. That is what US Treasury Secretary John Connally said to his peers at the Rome G-10 meeting in November 1971, right after President Nixon ended the dollar’s convertibility into gold which made the greenback, the world’s reserve currency. Since then the dollar reigned supreme, protected by a system of trade tariffs but came under pressure twice as tariffs were dismantled. Creditors sought other currencies and gold to protect themselves from the flood of dollars that allowed America to consume beyond its means. Today, America can no longer finance its debt domestically.  Thus, the dollar’s hegemonic role is being questioned by America’s creditors and there are clamors for a new monetary order. We believe gold is a good thing to have. It is a hedge against monetary disorder and protection against the central banks’ growing move to control savings and money. No wonder there is a shortage of gold.

Gold A Hedge Against Debt Monetisation

And, around the globe, the carry trade of borrowing dollars, investing the proceeds in higher-yielding bonds elsewhere is particularly risky. Floating currencies have been in a stealth currency war. China, the biggest trader has seen its currency decline some 6 percent. The US is the world's biggest debtor. The potential nightmare is that America's trading partners, in particular Asia tire of buying US Treasury bonds and then the flood of paper could swamp the market. To be sure an adjustment is necessary and inevitable. Meantime the general tone is darkening.

Gold was money for thousands of years but in the last 50 years, gold has been relegated to the monetary sidelines. However, China and Russia have been accumulating gold every month for the past 20 months as a protector and hedge against the stacks of dollars they hold in reserves. The coming inflection point is that a Trump announcement or attempt to fix the system may have collateral damage of a lower US dollar, particularly when borrowers seek to get liquid or when creditors worried about repayment, trigger massive distress selling. The herd instinct would take place here. Gold is a good thing to have against debt remonetisation, currency devaluation and the expected pickup in inflation. We continue to believe gold will reach $2,200 per ounce, within 18 months.

Recommendations

Gold miners will continue to be on the acquisition trail in order to replace reserves as reduced exploration budgets typically brought reduced results. Reserve replacement will require acquisitions, particularly those projects having been found, now require financing. Last year of a dozen producers, only two replaced reserves. Today, it is cheaper to buy ounces on Bay Street than to explore in the field which is behind the Newmarket and Kirkland Lake merger. As such, we continue to like gold shares down here, with an emphasis on the major producers and junior developers.

Agnico Eagle Mines Limited

Agnico reported better gold production and a reduction in costs. Agnico benefited from increased output from Kittila and Goldex which produced 1.2 million ounces so far. Flagship LaRonde processed a richer grade of 4.47 g/t in the quarter which boosted results allowing it to revise upward its guidance for the year. Debt was reduced by some $154 million to $588 million against cash and equivalents of $627 million. Agnico Eagle is a large Canadian producer with eight operating mines in Canada, Finland and Mexico and hopes to produce 2 million ounces of gold in 2020, from its existing asset base. Agnico currently has 19.1 million ounces of reserves (251 million tonnes grading 2.37 g/t of gold at $1,100). We like the shares here.

Barrick Gold Corp.

Barrick reported another strong quarter with free cash flow well above analysts’ projections. Barrick is on track to reduce its debt by $2 billion this year and will likely exceed that. Net debt now stands at less than $6 billion and Barrick is in the process of opening up the envelopes to sell its 50 percent stake in Kalgoorlie in Australia. While Kalgoorlie is on Barrick’s book at a half billion dollars, healthy competition for that interest including a bid from operator Newmont could see a $1 billion price tag. Barrick is the world’s largest gold producer with 16 operating mines and holds the largest in situ gold reserves in the world at 90+ million ounces. Barrick does not need to acquire any more mines because it is well positioned to grow organically. We continue to recommend the shares here.

B2Gold Corp

B2Gold reported a record quarter beating analysts’ projections producing almost 150,000 ounces. Costs were lower due to positive contributions from the Masbate Mine in the Philippines and Otjikoto. B2Gold has four mines, two in Nicaragua, one in the Philippines and one in Namibia. B2Gold benefited from the strong cash flow which will help Fekola to be completed in Q4 2017. B2Gold has cash and equivalents of almost $125 million which is enough to build out Fekola in Mali which is similar to their Otjikoto Mine. The miner raised its exploration budget to $11.4 million in Mali and is currently evaluating Kiaka in Burkina Faso, the potential next mine. B2Gold currently has three operating mines with a fourth on the way. We like the shares here for its organic growth prospects.

Detour Gold Corp.

Detour reported disappointing results due in part to lower production and guidance next year. The problem is that a portion of the Campbell pit had ground problems which will result in a loss of about 40,000 ounces. Unfortunately, the company could not assess the impact for 2017 and thus lowered guidance. A delay also in filing the environmental study report at West Detour also disappointed investors. Detour is a Canadian gold producer and yet with only 20 percent of its property explored, there is much blue sky. Detour has a long life reserve of over 16 million ounces of gold. However, the reduced guidance is of immediate concern because Detour must refinance $340 million of debt next year, having repurchased $60 million notes recently. As of the September quarter Detour had $116 million in cash. For next year, the slower development around the Campbell pit could adversely affect Detour’s plans and given the uncertainty, Detour shares have underperformed. We prefer B2Gold here.

Eldorado Gold Corp.

Eldorado reported a profit this quarter but the results also included the disposal of three remaining Chinese assets for which they received $900 million which will be used to fund Eldorado’s development plans. Work continues at Skouries and Olympias Phase II in Greece which will start up next year. Eldorado has two legs with flagship Kisladag and Efemcukuru in Turkey and development projects in Greece. High grade Olympias will produce 72,000 ounces next year at 1,200 tpd throughput. Eldorado will spend $40 million at Kisladag to boost output to 320,000 ounces from 250,000 ounces. We like the shares down here.

Goldcorp Inc.

Goldcorp reported disappointing results despite improved grades at flagship Penasquito in Mexico. Goldcorp produced 715,000 ounces at AISC $812 per ounce and maintained guidance. Goldcorp unveiled a resource at Dome Century as they developed a conceptual Ontario strategy using existing facilities to salvage the central processing hub in the Porcupine camp where reserves are depleted. Goldcorp is going back to the drawing board hoping they could also salvage the Borden acquisition but the overall capital cost is more than $1 billion. While Timmins could use the injection of cash, we have seen these ambitious plans before. We believe that Goldcorp still has to sort out its problems of focusing on lower cost mines and selling off some of their higher costs mines. Goldcorp expects to produce 2.8 million to 3.1 million ounces but Eleonore in Quebec remains a drag and it is too early to look for the Coffee project to come on stream. Moreover, of Goldcorp’s nine projects, five are only in the prefeasibility stage. We prefer Barrick here.

Kinross Gold Corp.

Kinross reported solid results from Fort Knox, newly acquired Bald Mountain and the Russian Kupol-Dvoinoye mines. Problem prone Tasiast in Mauritania resumed full production in mid August but still was a problem with costs approaching $1,200 per ounce. Kinross is completing most of the work on the Tasiast Phase two feasibility study but the price tag is in excess of $500 million. Phase one will reach full production in Q2, 2018.We believe that Kinross is just trading dollars around here. At Bald Mountain, Kinross hopes to double mineral reserves to extend its short-life. We prefer Agnico-Eagle here.

Newmont Mining Corp.

Newmont posted excellent results producing some 1.25 million ounces. Newmont was also able to sell Batu Hijau in Indonesia at a attractive price which also rids them of potential jurisdiction problems. Bottington, one of Australia’s largest mines had a good quarter and Newmont's Nevada operations performed well with higher grade Long Canyon coming on stream ahead of schedule and under budget. Newmont commissioned Merian in Suriname which will produce a modest 400,000 – 500,000 ounces during the first five years of operation. Newmont has operations in eight countries spanning five continents. We prefer Barrick here for its superior growth potential and array of quality assets.

New Gold Inc.

New Gold reported a modest quarter with production at 96,000 ounces. The key however is Rainy River which is now 60 percent complete and the company received the environmental permit to start construction of the tailings dam. New Gold is still in the spending mode and cash flow was negative as it builds out Rainy River which should be in production by mid-2017. The company has about $150 million in cash and $275 million left on their revolver which should be sufficient to complete Rainy River ($425 million left to spend). New Gold has four gold operating mines located in Australia, Mexico, California and British Columbia.

Yamana Gold Inc.

Yamana eked out a small profit on production of 329,000 ounces and 1.7 million ounces of silver. Flagship El Penon in Chile was weaker and the company is working on a revised mine plan to evaluate narrower veins and to lower costs. Canadian Malartic increased output by 5 percent and Chapada had higher copper output. Yamana’s balance sheet is still fragile with cash of $240 million or so but debt stands at a whopping $1.5 billion. Mercedes was recently sold. Yamana has $94 million of debt repayments over next 12 months and an undrawn facility of $820 million. In an attempt to raise funds, Yamana spun off Brio Gold to shareholders through a rights offering which was only valued at $360 million. Yamana will still own 46.3 percent and did not net much.  We prefer B2Gold here.

John R. Ing

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