Metals Commentary: Economic uncertainty drives gold prices higher

The first gold pour from Agnico Eagle Mines’ Meliadine mine in Nunavut. Credit: Agnico Eagle Mines.

The gold industry feels optimistic for the first time in years, as the price of the precious metal steadily rises amid fears of a global economic downturn. Gold miners, in the meantime, vow to stay disciplined to avoid becoming overleveraged, as some were during gold’s last run-up.

At around US$1,525 per oz., gold is trading at its highest level since 2013, and is up about 20% so far this year. Gold hit a six-year high of US$1,550 per oz. in late August, as investors sought a haven from the intensifying U.S.–China trade dispute.

Recession fears, trade wars, political uncertainty around Brexit and easing monetary policy by various central banks around the world are also fuelling the price of gold and gold investments. Sprott Gold Miners ETF (SGDM) and VanEck Vectors Junior Gold Miners ETF (GDX) are each up by about 40% year-to-date.

“People are responding to gold as a safe haven and portfolio diversifier,” Rohit Savant, vice-president of research at CPM Group, said in an interview. He forecasts gold will average US$1,410 per oz. in 2019, up 11% from last year, and rise to an average US$1,600 per oz. in 2020.

Doré from Agnico Eagle Mines’ Meliadine mine in Nunavut. Credit: Agnico Eagle Mines.

“We definitely see prices going up,” Savant says. “If you have a combination of longer-term investors and short-term investors, as well as central banks buying … that combination will propel prices higher. That’s what we expect will happen in 2020.”

Bart Melek, head of commodity strategy at TD Securities, also forecasts gold will average US$1,600 per oz. next year, with some volatility along the way.

“The bulls who want to know when and how far gold prices will rally need only be patient for a short while longer. But they also need to be ready to see a modest drift lower in the short-term, as even a bull run never follows a smooth path,” Melek and his colleagues state in a Sept. 5 note.

In the meantime, Melek says portfolio weightings have already started to “tilt aggressively” into gold.

“The good news is that public, private and corporate debt around the world has skyrocketed, the business cycle is growing very long in the tooth, equity market risks have grown, and volatility is trending higher,” Melek writes. “And since gold is very much a diversifier and a hedge for tail risks, money managers will continue to increase their allocation of capital into the metal.”

Demand for gold and other haven assets should also increase, as the risk for a recession, or at least correction, increases. Melek says there is also growing market conviction that central banks around the world could turn to quantitative easing when their economies stall, or fall, which is “more fodder for the view that asset allocations will continue to tilt toward hedge assets … all this suggests that metal in vaults will likely stay there, which means that the extra demand should stress primary supply-demand fundamentals.”

Sean Boyd, CEO of Agnico Eagle Mines (TSX: AEM; NYSE: AEM), says he saw a shift in sentiment towards gold a couple of years ago, when “big money” began doing more due diligence on the sector. However, it wasn’t until gold hit US$1,400 per ounce that the interest became more pronounced.

“It’s another sign that people are starting to change their perception on gold to one that was total disrespect and disdain to ‘hey, maybe this is something we should own,’ because the [economic] environment going forward is a lot more uncertain,” Boyd said in an interview.

He forecasts the gold price could hit an all-time high above US$2,000 per oz. in the next couple of years. Gold’s record right now is just above US$1,900 per oz. in 2011.

“This is a perfect environment for gold to do extremely well,” Boyd said, while crossing his fingers that the price increase will remain steady and sustainable. “What we don’t want is for gold to go up too quickly,” he said. “Any time you’re in the early stage of what should be a strong cycle and bull market — I would call this the start of a bull market in gold — you don’t want too much volatility. We want big money, we want smart money to be comfortable and work their way into positions. Volatility, or extreme volatility, is never good.”

Investors are also wary about getting overexcited about gold, having suffered from the mistakes some miners made at the start of the decade by over-leveraging assets based on strong prices — only to see them fall, forcing massive project write-downs and cost cuts.

“What the industry has to do is not get complacent … to focus on costs and be laser-like in focusing on delivering margin expansion,” Boyd said. “It’s going to take some discipline from the industry, which I expect for the most part we are going to see.”

Boyd vows Agnico will remain measured in its growth, even if gold prices continue to rise as forecast.

“We aren’t going to start to take marginal projects off the shelf and start building them,” he said. “We have got enough in our pipeline to continue to steadily grow this business over the next five years from an annual production standpoint, just by working things that already exist in our current pipeline, which were analyzed at US$1,200, or US$1,250 gold.”

Agnico could accelerate phase two of its Meliadine and Amaruq projects, if gold’s gains are sustained, he said.

“We have to continue to be measured and really stay focused on continuing to deliver a high-quality business that’s focused on net-free cash flow generation,” Boyd said, adding that investors are looking for “net-free cash flow, increased dividends and steady, well-run businesses that do what they say they’re going to do.”

Mark O’Dea, chairman and founder of Oxygen Capital, which has four exploration-stage companies, including Pure Gold Mining (TSXV: PGM; LON: PUR) and Liberty Gold (TSX: LGD), said higher gold prices will increase project valuations, which, in turn, should boost investment in companies and the industry overall.

“The spotlight is on the sector again,” O’Dea said in an interview. “North American investors are going to wake up to the fact that there are some good opportunities here.”

Well-known resource investor Eric Sprott has invested about $140-million in 18 exploration companies so far this year, according to the Globe and Mail, including $20-million in Oxygen’s Pure Gold Mining for a 10% stake.

O’Dea hopes to see more venture capital come back to the mining space, having been focused on sectors such as marijuana for the past two to three years.

“It’s a phenomenal time to get back into the resources sector, because prices haven’t taken off yet. They have bounced … but there’s still more room to go,” O’Dea said.


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