au en false false Default

Mania clouds risk despite gold merger bright spot

 
Gold prices continue to consolidate while risks created by a Fed tightening cycle are all but ignored. Long-term post-pandemic structural changes may prove positive for gold in 2022.

Gold prices have now been consolidating for over a year since hitting an all-time high of US$2,075 per ounce in August 2020. During September, the US Dollar Index (DXY) broke out to a one-year high and pressured the gold price, which finished the month with a US$56.67 loss at US$1,756.95. A spike in US interest rates following the September Federal Open Market Committee (FOMC) meeting in which the US Federal Reserve (Fed) suggested it could begin tapering its US$120 billion per month purchases of US Treasuries and mortgage-backed securities in November, also weighed on the price of gold. The Fed also indicated it might begin raising key interest rates as soon as late 2022.

Market mania overshadows potential risks

We believe that myriad of risks may come with a Fed tightening cycle, including:

  • A grinding halt to stimulus-fueled economic growth;
  • Problematic debt service costs with higher interest rates; and
  • A collapse of bubbles in stocks, bonds, crypto assets and housing.

While we believe that these risks will eventually drive gold prices higher, markets are currently in a euphoria where complacency reigns and risks are ignored.

In 2021, the average daily notional value of stock options traded is set to surpass the value of underlying stock trades for the first time. According to the Wall Street Journal, initial public offering (IPO) activity has already surpassed that of every full-year on record. Sales of junk-rated bonds and loans have also topped previous annual highs. Non-fungible tokens (NFTs) of digital art are selling for millions in a bubble reminiscent of the seventeenth century tulip mania, when a single tulip sold for more than houses.

Frothy markets do not worry about risks and do not see a need for safe havens. As a result, gold has fallen below its bull market trend base, shifting to a sideways consolidation in a wedge pattern with a new base around US$1,680.

Gold’s sideways consolidation establishes a new US$1,680/oz base

Gold's sideways consolidation establishes a new $1,680/oz base

Source: Bloomberg, VanEck Estimates

Miners remaining firm on commitments

We attended the Gold Forum Americas conference in Colorado where gold companies gather to meet with investors each year. This year was a hybrid event and we were happy to meet face-to-face with many of our companies. The key takeaway from the conference is that the transformation we have witnessed over the past five years is lasting and fully engrained in the culture of the industry. Many companies demonstrated their commitment to strong cash flow, capital returns, organic development to extend mine lives, technological advances and sustainability.

Having underperformed gold in yet another month this year, with a fall of 8.72% in the NYSE Arca Gold Miners Index compared with a 3.12% fall in the gold price, we continue to see gold stocks as undervalued. 

Major deal (of majors)

A major deal was announced on 28 September that, once approved by shareholders, will combine Kirkland Lake with Agnico-Eagle to create the world’s third largest gold company.

We like the deal for two reasons:

  • It was structured as a friendly merger of equals (MOE) where no premium was offered — This is another aspect of the industry’s transformation that we have talked about before at length where, in the past, we have seen many premium deals end in tears. Unlike premium deals, a MOE minimises speculation and arbitrage activity, leaving most of the stock in the hands of shareholders who judge a deal on its fundamentals. It also avoids selling pressure in the acquirer’s stock and the churning of stock that often occurs following a premium deal.
  • We like the creation of a third industry leader — Barrick and Newmont are already recognised as “super-majors” and industry leaders. At 3.5 million ounces per year, the new Agnico does not rise to the level of a super-major (typically producing five to six million ounces per year). However, other attributes enable Agnico to enter the big leagues. The merger sets it apart from other majors in terms of production, its costs are expected to be lower than the super-majors’, and it has the lowest geopolitical risk with 75% of production coming from Canada and the remainder from Finland, Australia and Mexico.

Divergent views on inflation “from the top”

Over the past year, US inflation, as measured by the headline consumer price index(CPI) rose 5.3%, US producer price index (PPI) gained 8.3%, and EU CPI (as measured by the Harmonised Index of Consumer Prices) reached a 13-year high of 3.4%. Central bank and business leaders seem to have divergent views on this inflation: Here is just a selection of such divergent views:

  • “The current bout of elevated inflation in the U.S. is tied to the reopening of the economy as it recovers from the pandemic and won’t lead to a new regime of higher inflation going forward” – Fed Chairman Jerome Powell, Bloomberg, 29 September 29, 2021.
  • “There are no signs that this increase in inflation is becoming broad-based across the economy” – EU Central Bank President Christine Lagarde, Bloomberg, 28 September 2021.
  • “Our prices are going up for the remainder of the year as we see inflation going up” – General Mills CEO Jeff Harmening, WSJ, 22 September 2021
  • “We’re not expecting supply chain pressures to ease” – Bed, Bath, & Beyond CEO Mark J. Tritton, New York Times, 1 October 2021
  • “The impact of constrained labor markets remains the biggest issue facing our business” – FedEx COO Raj Subramaniam, WSJ, 22 September 2021

Bureaucrats in Washington and Brussels do not seem too worried, whereas some of the business leaders on the ground are concerned.

For most, inflation is already here

Increased overtime, higher wages to attract new workers and extra spending on transportation added US$450 million to costs in FedEx’s quarter ending 31 August 2021. Help wanted signs are common here in the New York tristate area. We spent some time traveling in the Inter-Mountain West recently, where labour is even tighter. One restaurant billboard simply posted “Name your Wage”.

The Federal Reserve Bank of New York’s August survey found consumers expect inflation of 5.2% in a year and 4.0% in three years. Expectations might be conservative, as the S&P CoreLogic Case-Shiller National Home Price Index9 had an annual rise of 19.7% in July, an all-time record.

Supply woes adding fuel to the fire

Supply chains are being realigned and businesses are relocating sources of production, creating bottlenecks that limit supply. Record numbers of container ships are parked off the coasts of California and Georgia, waiting for warehouse space and trucks to ship the goods inland. Factories in China are being forced to close intermittently to conserve power as the US trade deficit surged to a record in June. Meanwhile, according to a recent Wall Street Journal "Car Chip Crisis to Extend for Years."

While some inflation drivers are related to the reopening of the economy, it seems the majority are long-term post-pandemic structural changes in consumer behaviour, the workforce, raw materials dynamics and production and transport of goods that all point to a sustained period of rising prices. Perhaps the most compelling argument is the fact that for years, easy monetary policies, and more recently fiscal policies, have been stoking inflation.

We would expect, then, the gold to react in 2022 if inflation metrics remain elevated in the longer-term.

Published: 11 October 2021

IMPORTANT DISCLOSURES

VanEck Investments Limited ACN 146 596 116 AFSL 416755 (‘VanEck’) is the responsible entity and issuer of units in the VanEck Gold Miners ETF. This is general advice only, not personal financial advice. It does not take into account any person’s individual objectives, financial situation or needs. Read the PDS and speak with a financial adviser to determine if the fund is appropriate for your circumstances. The PDS is available here. The Target Market Determination is available here

An investment in GDX carries risks associated with: financial markets generally, individual company management, industry sectors, ASX trading time differences, foreign currency, country or sector concentration, political, regulatory and tax risks, fund operations and tracking an index. See the PDS for details. No member of the VanEck group of companies guarantees the repayment of capital, the payment of income, performance, or any particular rate of return from any fund.

NYSE® Arca Gold Miners Index® is a trademark of ICE Data Indices, LLC or its affiliates (“ICE Data”) and has been licensed for use by VanEck in connection with the US Fund. Neither the Trust nor the Fund is sponsored, endorsed, sold or promoted by ICE Data. ICE Data makes no representations or warranties regarding the Trust or the Fund or the ability of the NYSE Arca Gold Miners Index to track general stock market performance.

ICE DATA MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND HEREBY EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE WITH RESPECT TO THE NYSE ARCA GOLD MINERS INDEX OR ANY DATA INCLUDED THEREIN. IN NO EVENT SHALL ICE DATA HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.

Please note that the information herein represents the opinion of the author, but not necessarily those of VanEck, and this opinion may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.

© 2021 VanEck