Gold Regains Strength After Post-Election Decline
TOM BUTCHER: Gold ended 2016 on a weak note, having broken a very positive trend that dominated most of the year. Do you see further weakness or improvement in 2017?
JOE FOSTER: You have to look at the timing and the reasons for the weakness in the gold market. Most of the decline came after the U.S. presidential election on November 8. It was amazing to watch investor sentiment and psychology change from an outlook of uncertainty to one that was very optimistic, and rosy. The new positive outlook was that the changes that President Trump had proposed — tax cuts, infrastructure spending, changes in the regulatory climate — would likely generate robust economic growth that would enable the Federal Reserve to normalize interest rates in a reasonable time frame. Not a typically bullish scenario for gold.
We disagree with that rosy outlook and think the market was being irrational after the election. Gold is starting to recover, with the price rising through $1,200 an ounce. The market is realizing that there are risks out there and that this optimistic scenario may not play out.
We see three major obstacles to the optimistic outlook, ones that are ultimately favorable for gold. One is the tremendous debt that the U.S. is carrying. The tax policies outlined in Trump’s campaign would raise our debt levels by trillions of dollars over the next 10 years. And we simply can't sustain more debt. The second is that we are in the late stages of the current economic cycle. This expansion has been going on for about seven years now, and expansions do not go on forever. We think there is a chance that the next recession could happen in Trump's first term. If the Fed raises rates as it has announced, there will be even more drag on the U.S. economy. The final obstacle is uncertainty about Trump himself — controversy about his foreign policies, his immigration policies, and some of his domestic policies. These uncertainties create risk going forward that could drive the gold market.
BUTCHER: What do you think are the most positive trends for gold stocks now?
FOSTER: There is a strong trend toward lower costs, better capital allocation and better management decisions across the gold industry, and we expect this to continue for the foreseeable future.
Another positive trend is the success of emerging gold producers, which are junior companies that are developing significant gold deposits. Companies like Roxgold, Torex, and Guyana Goldfields1 started mining significant large-scale gold deposits in 2016. They brought these properties, which have been in development for years now, onstream on time and on budget. They are finally producing gold and making good money. As we look ahead, we are very excited about companies like Pretium, TMAC, Continental Gold, and Gold Road.
BUTCHER: Moving from supply to demand, India and China have historically been huge consumers of gold. Do you see this continuing in 2017?
FOSTER: The short answer is yes. India and China are the top two gold consumers in the world. Even in a bad year, they are very large consumers, which we saw last year. Indian demand was especially weak last year due to factors including India’s tax policies and its new currency regime, but the gold price still went up. As we move through 2017, we expect continued weakness in Indian demand and stability in Chinese demand.
A source of demand that has just come into view is the Middle East, where there has been a change in Shari’ah law2. Previously, there was uncertainty about whether Islamic countries could invest in gold bullion or gold stocks. The authorities there have adopted an interpretation of Shari’ah law that enables individuals and institutions to invest in gold bullion, gold coins, and gold stocks. This is especially important for institutions like the sovereign wealth funds and high-net-worth funds. We think gold will be a new investment choice for those types of investors, and it could bring additional demand to the gold market.
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1As of 12/31/16, Roxgold represented 1.13% of VanEck International Investors Gold Fund; Torex Gold Resources 2.43%; Guyana Goldfields 1.70%; Pretium Resources 1.08%; TMAC Resources 2.18%; Continental Gold 3.39%; and Gold Road Resources 2.17%. Please INIVX Portfolio Analytics for a full list of up-to-date Fund holdings.
2On December 5, a second potentially favorable development for gold occurred when the Shari'ah Standard on Gold (the "Standard") was released by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI).5 The Standard, for the first time, sets out specific rules for the use of gold as an investment in the Islamic finance industry. Until now, there have been no such rules and this has led to confusion over whether or not Islamic households are permitted to invest in gold. Those who wanted to own gold were compelled to invest only in jewelry. The Standard also rules that it is permissible to invest in gold mining stocks. This opens a significant segment of the global population that already has an affinity for gold to initiate potential investments in gold bars, coins, ETPs, and stocks.
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