Weaker US dollar, investment demand sustains gold's momentum in April

Gold's positive momentum continued in April. Bullion traded as high as US$1,289.60 per ounce on 18 April, driven primarily by weaker than expected US economic data. Most notably, figures released in the US jobs report were below expectations.  US Factory output also surprised on the downside. Gold also gained support from comments by President Trump, during an interview on 12 April, in which he stated that the US dollar was getting too strong and that he would prefer that the Fed keep interest rates low. By 18 April, markets were not pricing in another Fed rate hike in June, with the implied probability at only 43.7%. However in the last week of April markets perceived the outcome of the first round of the French presidential elections positively, fuelling risk-on sentiment and pushing down the price of gold. As of 1 May, markets were attaching a ~70% probability to a June Fed rate hike and a 72% probability to a July hike. Gold ended April at US$1,264 per ounce, up US$18.94 or 1.52%.

Gold stocks display rare behaviour relative to bullion

Gold stocks underperformed the metal, which is uncharacteristic for a period in which the price of gold increased. The NYSE Arca Gold Miners Index (GDX Index) was flat during the month.

 The underperformance was driven by a 12% drop in the share price of Barrick Gold. On 24 April, Barrick reported 1Q 2017 results that missed expectations, primarily due to operational issues that the company expects to resolve shortly. However this was received very negatively by markets, which have become accustomed to Barrick consistently meeting or exceeding expectations. Although there were a few other negative surprises, overall, the seniors and mid-tier companies reported 1Q results that met or exceeded expectations.

Gold equities should outperform gold bullion during rising gold prices and underperform if gold prices fall. Although this expected relative performance may not hold during certain periods (as was the case in April), gold equities have consistently demonstrated their effectiveness as leverage plays on gold during the past several years as shown in this chart.

Gold Stocks Typically Provide Leverage to Bullion
2012-2017

Source: Bloomberg. As of April 28, 2017. Past performance is not indicative of future results.

Gold market in April provides insight for 2017 and beyond

It is conceivable that the gold market for the year 2017 may end up looking like it did in April which was characterised by short rallies followed by pullbacks, as the market's assessment of the health and prospects of the US economy and the Fed's rate outlook lifts or depresses the gold price. We see the gold price well supported within a range centred on the US$1,250 per ounce level in 2017, as it establishes a new base that started forming in 2016. There is potentially significant risk and uncertainty that could drive the gold price higher, and it certainly seems possible that the geopolitical or financial outlook could turn negative rather quickly. Beyond 2017, adverse events, we believe, become increasingly likely as the post-crisis expansion ages especially if the bull market in stocks and bonds loses steam. These are the types of "risk-off" events that we believe will likely compel investors to seek protection by investing in gold and gold equities.

Gold stocks typically provide leverage to gold and current valuations remain attractive 

Gold mining equities offer leveraged exposure to gold. The leverage comes from earnings leverage; as the gold price increases, the change in the company's profitability significantly outpaces the change in the gold price. In addition, at higher gold prices, in-the-ground resources have a higher value, and the company's exploration efforts, project expansions, operational improvements, and potential acquisitions also become more valuable. This explains why gold stocks trade at premium valuation multiples. Looking at historical valuation levels, as illustrated by the price-to-cash flow chart below, we see that stocks are currently trading at multiples that are below the long-term average, and well below the multiples reached during the peak of the last bull market.

Historic Price-to-Cash Flow of Gold Majors and Mid-Tiers
2006-2017

Source: RBC Capital Markets. Data as of March 17, 2017. Past performance is not indicative of future results.

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