Joe Foster

Our positive view on the long-term prospects for gold remain unchanged. The U.S. elections are over, and markets will likely take time to reflect the full impact of a Trump victory.

Gold immediately rose above USD$1,300 per ounce after the news of Trump’s win, but has since settled back to USD$1,230. Price volatility in the short run is not surprising.

Trump presidency may increase financial risk

With the contentious presidential election finally over, we can now assess the impact that the Trump victory will have on the country and more importantly, how it potentially increases risk to the financial system.

Although Trump emerged successful in the election, there remains tremendous uncertainty surrounding his morals, temperament, and judgment. Internationally, high levels of trepidation around his foreign policies are not likely to subside quickly, and his anti-trade stance could damage economic growth. In our opinion, Trump’s aggressive immigration policy was no doubt one of the key drivers of his appeal but could lead to potential civil unrest, extreme costs, and logistical challenges once implemented. If Trump is able to implement some of what he promoted during the campaign trail, infrastructure spending could push the national debt to unsustainable levels and deficit spending should continue. While the risks of a Trump presidency are substantial, the potential for pro-growth tax and regulatory reforms may partially mitigate risks.

Independent of policy specifics, there exists a growing chance our newly elected president will likely preside over the next recession. After eight years of expansion, there are signs that the economy has entered the “late cycle” phase. The Fed’s efforts to tighten policy could create a further drag on growth. A recession layered onto the existing risks we see in a Trump presidency, in our view, makes a systemic financial crisis more likely.

Fed comments on December rate hike break gold’s upward move

The strong price movements that followed the U.K. Brexit vote on June 23 had set gold on a new positive trend, breaking the downtrend that had been established during the 2013-2015 gold bear market. On October 4, however, gold fell $44 per ounce, a 3.4% drop for the day, and gold closed below $1,300 per ounce for the first time since June 24. As it had for most of the year, the downward pressure followed comments by some Federal Reserve (the “Fed”) members that were interpreted by the market as increasing the likelihood of a Fed interest rate hike occurring in December. In addition, and importantly, Chinese markets were closed the first week of October for the Golden Week holidays. With gold’s biggest buyer out on vacation, gold was left very vulnerable, which we believe emboldened short sellers. Gold closed as low as $1,251 per ounce on October 14 but bounced back modestly to end the month at $1,277.30 per ounce, down $38.45 or 2.9% for the month.

A rate increase has been priced into gold and U.S. dollar

At the beginning of November, markets attached about a 78% probability to a December Fed rate hike, as implied by the federal funds futures markets. This probability stood at 59% at the end of September, despite U.S. macro data releases that were very mixed, as has been the case throughout the post-crisis recovery. There were certainly some positive economic surprises in October: PMI (Purchasing Managers’ Index) readings from both the ISM (Institute of Supply Management) and Markit Group in the manufacturing, non-manufacturing, and services sectors showed some expansion and an increase in August factory orders for U.S. goods.[1]

In contrast, however, weak data were reported for U.S. employment, the preliminary University of Michigan Consumer Sentiment Index,[2] the Empire State Manufacturing Index,[3] housing starts, and the U.S. Consumer Confidence Index.[4] While 3Q gross domestic product (GDP) headline growth was above consensus, personal consumption missed expectations by a wide margin. By mid-October, regional Fed growth forecasts were being downgraded. The Federal Reserve Bank of New York’s 4Q 2016 GDP Nowcasting Report, for example, shows 1.4% growth as of October 20 versus 2% growth in late August. In this environment, a rate hike does not appear to us as the obvious next move by the Fed, but the market is pricing it in, and both gold and the U.S. dollar reflected this in October. While gold was down 3%, the U.S. Dollar Index (DXY)[5] was up 3% during the month.

Demand for gold withstood recent selloff

Despite the drop in the gold price in October, demand for gold bullion-backed exchange traded products (ETPs) held firm. Inflows have no doubt slowed down compared to earlier in the year (0.4% increase in holdings in October compared to 12% and 6% increases in February and June respectively), but demand continued during the recent selloff. We believe this is positive since investments in gold bullion ETPs typically represent longer-term, strategic investment demand. In contrast, the latest Commitment of Traders report shows a significant decline in COMEX[6] net long positions, which reached record levels this year. We think COMEX positioning reflects more speculative and shorter-term demand for gold, and the recent decline suggests perhaps some of those weaker players liquidated positions during the October selloff.

Election uncertainty and Asian demand should support gold

The gold price is on a slightly different track now compared to our previous expectations. A correction was not surprising, given gold’s outstanding performance this year. But we thought that the $1,300 level might hold and gold would continue on the new trend established this year, potentially exiting 2016 around the $1,400 level. Although our shorter-term outlook has been curbed by the recent price action and we now think that gold may not reach $1,400 in 2016, we believe strong seasonal demand out of Asia and continued uncertainty following the results of the U.S. presidential election could lend support to gold in the near term. In the first week of November, gold managed to rally back above $1,300. The Fed decided to keep rates unchanged at its November 2 Federal Open Market Committee (FOMC) meeting, but this was widely expected, so we estimate the positive move was most likely driven by market concern over the outcome of the U.S. elections. Market views quickly shifted, once again, and on November 8, Election Day in the U.S., gold closed at $1,277. Following Trump’s stunning victory, gold rose back above the $1,300 price level on the morning of November 9.

Higher rates not always negative for gold

A Fed rate hike in December appears almost fully priced-in already. The common argument is that higher rates are negative for gold given that it is a non-yielding asset. Yet, following the first rate hike of the current tightening cycle in December 2015, gold has advanced more than 20% so far this year. In fact, Scotiabank analyzed the previous six tightening cycles since 1982 (when a suitable gold index became available) and it found that gold prices advanced in the year following the first rate increase in half of the cycles, whereas gold declined in the other half.

Scotiabank points out that the only other point at which the Fed raised rates in a low-inflation environment was in 1986 when rates were increased to help defend a sharply depreciating U.S. dollar. It was one of the rate-rising periods when gold performed well. This is shaping up to be a similar period demonstrated by gold’s already strong performance after the first rate increase in December 2015. The economic and financial backdrop of the current rate cycle is unlike any other in recent history, and we expect gold to continue to perform well. In our opinion, the stress that rising rates have the potential to place on the global economy and financial system are very bullish for gold.

Long-term outlook remains positive for gold bull market

Our view on the long-term gold price is unchanged. We see the recent weakness as a consolidation phase within what we believe is the early stages of the next bull market for gold. We continue to believe dislocations created by the unconventional policies being implemented by central banks around the world are likely to increase global financial risks. We believe that investors will continue to be driven to gold as a safe haven given the further loss of confidence in central banks on a global scale and perhaps domestically, and the uncertainty following Trump’s presidential victory.[9]

By Joe Foster, Portfolio Manager and Strategist, VanEck

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[1] Purchasing Managers’ Indexes (PMI) are economic indicators derived from monthly surveys of private sector companies. The two principal producers of PMIs are the Institute for Supply Management (ISM), which originated the manufacturing and non-manufacturing metrics and which produces them for the United States, and the Markit Group, which produces metrics based on ISM’s work for over 30 countries worldwide. ISM and Markit Group separately compile Purchasing Managers’ Index (PMI) surveys on a monthly basis by polling businesses which represent the makeup of the respective business sector. ISM’s surveys cover all NAICS categories. The Markit survey covers private sector companies, but not the public sector
[2] The University of Michigan Consumer Sentiment Index is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in December 1964. Each month at least 500 telephone interviews are conducted of a continental United States sample.
[3] The Empire State Manufacturing Index is based on the monthly survey of manufacturers in New York State and conducted by the Federal Reserve Bank of New York. The index is based on survey responses to a questionnaire sent out on the first day of each month to an unchanged pool of about 200 top manufacturing executives, generally the president or CEO. The questionnaire seeks their opinion on the change in a number of business indicators from the previous month, and also the likely direction of these indicators six months into the future.
[4] The U.S. Consumer Confidence Index (CCI) is an indicator designed to measure consumer confidence, which is defined as the degree of optimism on the state of the economy that consumers are expressing through their activities of savings and spending.
[5] The U.S. Dollar Index (DXY) indicates the general international value of the U.S. dollar. The DXY does this by averaging the exchange rates between the U.S. dollar and six major world currencies: Euro, Japanese yen, Pound sterling, Canadian dollar, Swedish kroner, and Swiss franc.
[6] COMEX is the primary market for trading metals such as gold, silver, copper and aluminum. Formerly known as the Commodity Exchange Inc., the COMEX merged with the New York Mercantile exchange in 1994 and became the division responsible for metals trading.
[7] NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold.
[8] MVIS Global Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver.
[9] Safe haven is an investment that is expected to retain its value or even increase its value in times of market turbulence.

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Mr Foster, Portfolio Manager for VanEck’s active gold equities strategy, said, “The fall in the gold price this week is a result of a strengthening US dollar and more hawkish views emerging from the Fed. There are also lessening fears about the impact of Brexit and perhaps most importantly, Chinese markets are closed this week which has no doubt impacted the support for gold.

“Gold has been trading in the US$1,300 – US$1,350 price range and has now broken below US$1,300. Despite recent events, our view hasn’t changed that gold is in the early stages of a long-term bull market,” Foster said.

“The gold price will be supported by a number of factors. The global economy is weak and is in no condition to withstand higher policy rates. A Fed rate hike could work against gold initially (stronger dollar), but in practice could be seen as a misstep that increases the risk of recession and financial stress. In addition, it creates imbalances if the Fed is tightening policy when every other central bank is easing.  If the Fed fails to raise rates in December we expect dollar weakness and the gold price to strengthen. Nonetheless, another potential rate hike will likely be a repeat of the one last December where there was significant stock market volatility that drove investors to gold as a safe haven,” he said.

“In the short-term, we believe the gold market will stabilise following this Friday’s US jobs report. Price weakness will also likely spur seasonal demand out of India and Asia.  These countries typically buy on price weakness and they are also about to begin their festival and wedding season,” he said.

“For gold stocks, we believe the current market is similar to the 2001 to 2008 bull market where mining costs subsided, profit margins expanded, and equities significantly outperformed gold. Other mining sectors ― coal, copper, iron ore ― are depressed.

“We believe higher gold prices will encourage increased mining activity, but the gold sector alone cannot generate cost pressures without increasing activity in other mining sectors. In fact, we would use copper as a barometer of inflationary pressures in the mining business. With copper currently at US$2.09 per pound, we would not anticipate inflationary pressures until copper trades above US$3.00 per pound,” Foster said.

“Mining companies are generally focused on cost savings across mining practices, technology implementation, procurement, and contractor costs. Companies are more focused on organic opportunities – lower gold prices have forced companies to look inward at existing operations and projects. Companies are looking at projects that require less capital with higher rates of return and phased expansions,” Foster said.

The following table shows the previous six bull markets in since 1971. The bull markets are classified as secular (long-term) or cyclical (bull phases within an overall bear market). According to Foster, the current gold bullion bull market bears similarity to the 2008 – 2011 secular bull market because this was a period of heightened financial risk due to unconventional central bank policies. During this period the gold bullion price increased by 145%.

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Joe Foster

The gold market is building strength and acting as a financial hedge against uncertain financial markets. The gold price traded above US$1,300 per ounce in May for the first time since January 2015 reflecting investors’ increasing unease towards a weakening financial system according to a leading US gold expert from VanEck.

Joe Foster, Portfolio Manager of VanEck’s Gold Strategies said, “Global conditions today aren’t that different than six months ago when gold struggled near its lows. In our view, the fundamental change is investors’ view of central banks. Investors are realising that central bank policies lack efficacy and have run their course without accomplishing their intended results.

“In general, central banks appear to be rapidly running out of options to help stimulate economies. In fact, rather than helping, quantitative easing, zero rates and negative rates have created distortions in capital allocation leading to the mispricing of assets and currencies, wealth inequality, and possibly other harmful, unintended consequences on the financial system. We think the solution of the world’s problems hinges on re-establishing robust economic growth,” Foster said.

“Another factor contributing to this year’s spectacular gold rally is the fact that gold mining businesses are in a much better position than they were a few years ago. They have successfully slashed costs, cut debt, gained efficiencies and generated cash. The elimination of short selling pressure has also supported the rise in gold stocks since they crashed in 2013,” he said.

“The gold price was much higher in 2011, topping US$1,921 per ounce, but we think the earnings power of the gold sector is greater now than back then. We estimate that a US$100 (roughly 8 per cent) move in the gold price from US$1,300 to US$1,400 per ounce would result in a 38 per cent increase in free cash flow for the majors in our research universe, while the mid-tier producers would see a 68 per cent increase in free cash,” Foster said.

The performance of gold stocks is another sign of strength of the current gold market. The NYSE Arca Gold Miners Index (GDMNTR)1 advanced 28.1 per cent in April. Many of the larger producers announced favourable first quarter results in April, which further boosted the performance of gold equities.

Russel Chesler, Director Investments & Portfolio Strategy, VanEck Australia said, “In early 2016, the gold market has “woken up” after a lengthy slumber and now, gold is “hitting the gym” and building strength. After a brief consolidation, the gold price reached its 2016 high in early May and ended the month of April up 5%. Meanwhile, gold equities look like they may be training for a “bodybuilding competition”, gaining nearly 30% in April.

“Gold has fallen off slightly this week as the US dollar hit a new three-week high following expectations the central bank could soon raise interest rates, however we still expect there to be opportunities for gold to rally as investors remain uncertain about financial risks.

“Gold is up 18 per cent YTD and gold equities are up 75 per cent. During the 5 year gold bear market, gold equities were down 80 per cent. Gold equities relative to the gold bullion price as measured by the Barrons Gold Miners Index2 is still below its 1942 lows and needs to increase at least another 25 per cent to get back to that previous historical low

“There is no doubt that gold has been front of mind for Australian investors. We are seeing strong inflows from Australian investors into the VanEck Vectors Gold Miners ETF (GDX) which was cross-listed on the ASX mid last year. GDX is one of the top 20 most traded ETFs on the NYSE, with an average daily trading volume in excess of US$1 billion,” Mr Chesler said.

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Gold undervalued: Van Eck Global

Gold stocks are likely to rise over the next year from their current undervalued levels. Additionally merger and acquisition activity could heat up with any rise in the gold price towards US$1400 an ounce, according to Joe Foster, Portfolio Manager of Van Eck Global’s gold strategies.

Mr Foster said in a recent outlook on the gold market that while the gold price and gold stocks are off their 2013 lows, further gains in price are likely given the extent of last year’s sell-off.

“Gold stocks have done very poorly over the last several years as they have been out of favour. It’s going to take a lot to make up the lost value that has been destroyed over the last several years.  We’re in the process of recovering that value,” said Mr Foster.

“Even though gold stocks are up from 2013 levels, with some stocks up some 30% or so this year, we think they’ve got a long way to go to reach fair value. Valuations still look very attractive to us now.”

Mr Foster said several factors could help support the gold price over the coming year, which has formed a solid base around US$1200 per ounce.

“Gold continues to trade in the US$1200 per ounce to US$1400 per ounce range and we maintain our view that the price has established an important base. Fundamentally, Chinese demand is expected to increase, and lower costs of production, heightened geopolitical risk and an absence of persistent bullion exchange-traded product (ETP) selling are helping to support the gold price at current levels,” he said.

“People are worried about events in Iraq, Gaza and stability in the Middle East generally. Ukraine remains unstable. We expect these uncertainties and conflicts to continue to underpin the gold price throughout this year and next,” he said.

“In the US, financial-market and monetary policy risk remain. In the current low-growth recovery the US Government has piled up trillions of dollars of debt that looks like it is here to stay. We like to think of gold as a hedge against irresponsible policies from Washington, D.C. and possible asset bubbles or inflationary pressures, particularly,” Mr Foster said.

According to Mr Foster, M&A activity will likely rebound with any further gains in the price to US$1400 per ounce, which could positively impact Australian gold miners.

“I think M&A will continue at relatively low levels, as long as the gold price remains at current levels. If we get a move through US$1400 an ounce and we see a more positive trend in the gold market, I would expect to see M&A activity start to heat up as valuations rise and higher takeover offers are made for gold miners,” he said.

“In the first quarter, we saw a hostile takeover attempt.  This underscores  my point that the takeover target, Canadian miner Osisko, wasn’t willing to be purchased at current valuations.  The acquirer, Goldcorp, had to go hostile.

“Osisko, in the end, was taken over by a combination of two companies, Yamana and Agnico. Again, takeover activity has been at low levels because companies aren’t willing to be taken over at these low valuations as this struggle indicated,” Mr Foster said.

“We haven’t seen much on the mega-merger front in recent times because a lot of that activity has already occurred; these companies are already at a very large size. In fact, there was recent news about changes in top management at Barrick. Barrick is the largest gold company in the world and we think that they realise that this mega gold company model might not be the best way to run a gold company.

“We could see changes at Barrick that reflect what we’re talking about, the fact that some of these companies have gotten too big for their own good,” Mr Foster said.

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Gold looking to improve price

Several factors could support further increases in the gold price for the second half of 2014, according to Joe Foster, Portfolio Manager of Van Eck Global’s gold strategies.

Speaking on the outlook for gold recently, Foster said geopolitical risks, and lingering concerns about developed economies could favour the gold price over the coming months.

“Geopolitical risks in emerging markets have probably been the main driver of gold this year. Investors’ concern of political unrest and a possible contraction in Thailand, Venezuela, Ukraine, and Turkey has led to an outflow of capital. With no resolution in sight for many of these countries, we think these geopolitical risks will continue to underpin the gold price throughout the year.

“Economic growth in China and its banking system is also a concern for investors. After clocking double-digit growth rates over the last three decades, China’s economy has slowed as the government repositions activity to rely more on domestic demand. Despite those efforts, China’s first-quarter annualised growth rate of 7.4% was the lowest level in 18 months. Any further signs of a slowdown in China could create financial risks that drive investors to gold,” Mr Foster said.

According to Foster, changes in gold demand in India and China could also generate further gains in the gold price.

“In the second half of 2013, gold demand out of India dropped off significantly because of exchange controls and import restrictions that were placed on the Indian gold market. There are talks this year about India reversing or relaxing many of those controls. If so, that could be another catalyst that could move gold prices higher later in the year.

“As for gold demand in China, in a recent report the World Gold Council predicts that its will remain flat in 2014. While some analysts have put a negative spin on this, we see it as positive for gold. Last year saw unprecedented demand as the Chinese stepped in to take advantage of the collapse in gold prices. Demand that approaches similar levels this year would still be very supportive of gold. The Gold Council further reckons that Chinese demand will rise about 25% in the next four years, which would likely be another significant factor supporting its price,” Mr Foster said.

“The current US recovery is now longer than the average for post-World War II recoveries, yet growth has been half the average and unemployment has never been higher at this stage in past recoveries. The withdrawal of US Fed stimulus may have unintended consequences, putting further pressure on a weak US economy. Gold could respond favourably if the Fed finds it needs to reverse its tapering initiative.

“On a more positive note, we believe valuations on gold stocks are very attractive. Mergers and acquisition activity is on the radar for gold miners around the globe, including those in Australia. Assets are the cheapest they have been in years and bigger gold miners will be considering their options,” Mr Foster said.

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