Stars aligning for next stage of gold bull market
Gold prices have now soared around 25 per cent this year, with the most recent spike coming in the wake of the Brexit vote.
Gold typically finds favour during times of financial stress as a safe haven, but the prospect of more monetary policy easing from central banks across the world has strengthened the precious metal’s longer-term investment case.
Fat Prophets went bullish on gold around US$260 an ounce back in 2000, just as the world was digesting the bursting of the dot-com bubble, and as ultra-low interest rates were to become the norm under the then chairman of the US Federal Reserve, Alan Greenspan.
Gold has had a stellar run since those lows, although not without some protracted corrections along the way.
We believe the stars are aligning for the next stage of the gold bull market. This, in our view, will likely see the previous all-time highs taken out and the price push beyond US$2000 an ounce over the next three years. Investors would do well to have some gold exposure in their portfolios.
(Editor's note: Do not read the following ideas as stock recommendations. Do further research of your own or talk to a financial adviser before acting on themes in this article).
US-dollar gold price
Image Source: Reuters
Gold is used in jewellery and has industrial applications, but a key driver of prices is its attribute as a “currency”. As such, we believe the bull market in gold is dependent on three key factors.
The first is the growing propensity for central banks to print money and continue to enforce easy monetary policy. We have yet to see any of the major central banks withdraw stimulus in any meaningful way since the GFC more than seven years ago.
In the wake of the Brexit vote, things are not likely to change any time soon. Looking further ahead, a massive Medicare hole in the US as the baby boomers grow old will also compel the Fed to accelerate the money-printing presses.
Second, more than $16 trillion in sovereign global bond issuance is priced on negative yields. History has not seen this situation before. The advantage that sovereign bonds once had, being a relatively secure way to store capital and earn a return, is gone.
So the disparity between the holding cost of gold (which pays a zero return) and the yields on government bonds has all but disappeared; one has to buy emerging-market debt or corporate bonds to get any form of return.
Not surprisingly, gold is increasingly being accepted as an alternative store of wealth where there is surety of capital return.
Third, gold is steadily re-monetising as a currency and we see this factor as being potentially the most powerful of all the catalysts. The world needs another reserve currency other than the US dollar, and the disintegration of the euro and the European Union would be a political and also a financial tragedy.
At a minimum, in the months and years ahead, we are going to see ongoing turmoil in global foreign exchange markets, particularly with the euro. All this is going to benefit the precious metals group and underpin the bull market in gold.
We therefore see any weakness in precious metal equities as a buying opportunity for those without sufficient exposure.
Demand and supply fundamentals are also providing a positive backdrop. According to the World Gold Council, top-line demand for gold in the March quarter grew 19 per cent on a year ago to 1,287 tonnes. Underpinning demand growth were investment inflows into products such as ETFs, which soared by 1,300 per cent in the same period to a hefty 364 tonnes.
The supply of gold, however, grew by only 5 per cent over the same comparative periods to 1,135 tonnes. Mine production for the March quarter only grew by 1 per cent on the 2015 quarter, to 734 tonnes.
Overall, the net effect of the movements in demand and supply for the March quarter was to push the gold market into a supply deficit of 152 tonnes. The absence of any major gold discoveries in recent years is also going to compound the upward pressure on prices should demand remain robust.
Source: World Gold Council
For investors wanting exposure to gold, and with the requisite risk appetite, buying shares in listed gold miners is one avenue. Gold miners are a “leveraged” play on gold bullion, with movements in the gold price having a “multiplier” impact on earnings and, in turn, share prices. This is great if gold prices are going up, but the reverse is true if the gold market were to unwind.
We believe that select gold exposures are warranted within the context of a diversified portfolio.
We favour high-quality producers and Australian companies are attractive given that the relative weakness of our currency has seen the Australian-dollar price of gold at around record highs.
We believe further weakness is in store for the Australian dollar as the Reserve Bank looks to reboot the economy through further rate cuts (and perhaps even quantitative easing), which will provide a further tailwind for earnings of domestically focused gold producers.
One of our preferred exposures is Evolution Mining, which is headed by Jake Klein. He has done a great job in building production scale through astute acquisitions and this is translating into record gold production for the company. Management guidance is for production of 800,000 to 860,000 ounces in FY17.
Cost control is another impressive aspect of Evolution and is enabling handsome margins at current gold prices in Australian and US dollars. The company expects costs for FY17 of A$985 to A$1045 per ounce.
Another stock we have a positive view on is Saracen Mineral Holdings, which is also looking at record gold production this year, with a further increase on its way. Saracen delivered 188,000 ounces of gold in FY16 and is targeting annual output of 300,000 ounces within two years.
Overall, we see the foundations being in place for the next leg of the bull market in gold, and for the golden years to continue for a while yet. If we are right, gold exposure will form a valuable component of an investor’s portfolio.
Exchange Traded Funds (ETFs) and other Exchange Traded Products (ETPs) has information on ETFs over commodities such as gold.