Focusing on gold’s resilient base

Gold trended higher early, but ended April slightly down as the US dollar strengthened

Gold trended higher in early April due to trade tensions between the US and China, prospects of airstrikes on Syria, and heightened inflation expectations following a higher than expected March Producers Price Index (PPI) and a 2.1% annual rise in the core Consumer Price Index. Gold topped at US$1,365 per ounce on 11 March. This level has been the price ceiling for gold since 2014. Gold subsequently moved lower as a number of generally positive economic releases enabled the US dollar to trend to its high for the year on 1 May. Gold was also pressured by real rates that moved higher with US Treasuries. The yield on the 10-year Treasury surpassed 3% for the first time since 2013.

For the month, gold incurred a small loss of US$9.65 (0.7%) to finish at US$1,315.35 per ounce.  

Despite no surprises in earnings, gold stocks with small gains

While there was a lack of positive surprises in first quarter earnings, gold stocks were still able to eke out gains as the NYSE Arca Gold Miners Index (GDX Index) rose 1.7%.

Gold’s resilient price floor has been rising since 2015; likely to be tested again

While US$1,365 per ounce has been the ceiling for the gold price, the floor has been rising consistently since 2015 in a positive trend of higher lows. The base of this trend is currently around the US$1,285 per ounce level. As expectations for a 12 June Fed rate increase mount, gold might test the trend’s base in the coming month. Given the resilience the gold price has shown amid concerns over geopolitical risks, trade tensions, and inflation, we would be surprised to see gold fall below this level. Perhaps gold will take another run at US$1,365 in the second half of 2018.

Response to earnings highlights lack of interest in gold stocks

A lack of interest in gold stocks over the past year has caused them to fall short of performance expectations, which we highlighted anecdotally in our March commentary. In an April report, RBC Capital Markets was able to quantify this by looking at performance following earnings beats and misses over the last five years. They found that the sustainability of gains from earnings beats has declined in the last two years. Meanwhile, losses on earnings misses have gotten much worse in the last 1-2 years and the loss is sustained over a longer period. RBC also found that the value traded per day in 2018 is at levels last seen at the end of the bear market in 2015, when gold bottomed at US$1,050. This points to a lack of buying interest. Absent are those momentum players that follow the winners who beat and value players that pick up the losers who miss. While this lack of interest sounds negative, we are excited by the opportunity it presents. We believe gold equities are undervalued, and the companies are fundamentally sound. A spark that moves the gold price through its US$1,365 ceiling may rekindle interest in the miners.

“Gold is where you find it”

According to an old prospector saying, “Gold is where you find it”. Many of the companies we follow have found it in very out-of-the-way places. Not next to a highway in Ohio, but near a glacier in British Columbia, in the Atacama desert at 14,000 feet altitude, or 10,000 feet underground in South Africa. Companies must be skilled at building infrastructure in these remote areas.

Understanding geopolitical risk

Gold is also often found in places with geopolitical risk. In order to invest in a company, we must be convinced geopolitical risk can be mitigated, if not eliminated by management. Geopolitical risk comes in various forms at the national, state/provincial, and local levels. The most common risks at the national level are changes in taxes or royalties and import/export restrictions. At the state/provincial level, there are risks of legislation that might make mining prohibitively expensive. At the local level, disgruntled groups may blockade an operation and unions sometimes engage in work stoppages. These risks tend to be higher in emerging or frontier countries; however, developed countries are not immune. For example, the largest open pit gold operation in Ontario, Canada has delayed expansion plans to 2026 due to a lack of support from a local Aboriginal community.

Conversely, places assumed to be politically risky to a generalist may, in reality, be very favourable mining jurisdictions. The West African nation of Burkina Faso is one of the best places to build a mine. The gold industry is growing and exciting discoveries are being found. The permitting process is straightforward and efficient. A mining culture has developed, and materials and supplies are becoming more available. While the general election in 2015 was not without drama, in the end there was a peaceful transfer of power. The gold industry is a significant part of the Burkina economy that no leader wants to disrupt.

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