12 January 2020
As we all know, when there’s trouble in the world, the price of gold naturally spikes. So, for instance, on 3 January tensions flared in the Middle East after a US airstrike killed the Iranian general Qasem Soleimani. Suddenly spot gold was 2.6% higher at US$1,569 an ounce. To the uninitiated this tendency of gold to react to trouble may seem like the basis of a successful trading strategy – simply sell when it’s peaceful, buy when there are wars and rumours of war. Indeed, you don’t have to buy or sell gold, just the stock of ASX-listed gold miners like Evolution Mining (ASX: EVN), Newcrest (ASX: NCM), Northern Star Resources (ASX: NST), St Barbara (ASX: SBM) or Regis Resources (ASX: RRL).
Only it’s not as simple as that. For one thing, how do you define ‘trouble’?
Trouble may not be as troublesome as it looks
Tensions in the Middle East rarely affect daily life in a place like Sydney, which is over 13,000 km from Baghdad. Indeed, a large part of the advanced industrialised world powers on day after day regardless of whatever trouble spot was on the news last night. And now that the US has won its energy independence, tensions in the Middle East generally mean a lot less trouble than they did in 1979 or 1990 or even in 2003 when the second Iraq War got started. If you’re old enough to remember, the world may have seemed to be a pretty troubled place in the first half of the 1980s with the Cold War still going on and all that, but gold still went from above US$800 an ounce at the January 1980 peak to under US$300 an ounce by early 1985. Or, how about that period from September 2011 to December 2015 when the world also seemed to be in a mess, but gold went from close to US$1,900 an ounce back down to a level not far from US$1,000 an ounce.
The big thing to appreciate about gold is that it tends to go through these long periods of rising or falling regardless of whether or not the evening news looks bad. Indeed, it’s been like that since the price of gold was fully decontrolled in the 1970s. If your memory stretches back far enough, you’ll recall that in the 1930s US President Franklin Roosevelt effectively pegged the price of gold at US$35 an ounce and, to keep it there, forbade US citizens to own gold. Gold traded freely in other parts of the world, but it didn’t really get much above US$35 an ounce until August 1971 when President Richard Nixon effectively ended America’s gold standard and the US dollar was allowed to float freely against other currencies. By the beginning of 1975, when it became legal once again for US citizens to own gold, the metal was close to US$190 an ounce.
1980 versus 2017 – the more things change…
In the mid and late 1970s, being the economically uncertain times they were, gold was off and running as the commodity people felt they needed, to protect themselves against the inflation of ‘fiat currencies’, similar to people buying Bitcoin for the same reason not long ago. As the old French saying goes, ‘plus ça change, plus c’est la même chose’ – ‘the more things change, the more they stay the same’. Just like Bitcoin eventually topped out at nearly US$20,000 in late 2017, gold’s 1970s bull run came to a screeching halt in January 1980 at around US$850 an ounce. It didn’t get back there again until a couple of generations had passed, in early 2008. The gold bear market from 1980 in effect lasted for 21 years. In February of 2001 gold was trading near US$260 an ounce and it only ended the year at around US$280 an ounce, although there was a brief spike just after the terrible events of 11 September.
Now, at that point you may be thinking, well, okay, so I buy when governments, particularly the US government, consistently run deficits, and sell when they begin to get their budgetary act together again, which they tended to do in the 1980s and 1990s thanks to the kind of economics espoused by Thatcher, Reagan et. al. Only even with that theme you need to be careful. Sure, gold rose steadily from 2001 to 2011 largely because of America’s and Europe’s fiscal irresponsibility, which became crazy in the aftermath of the Global Financial Crisis. But the peak was when profligate European countries were going bankrupt in 2011. Then, as we’ve noted above, another bear market kicked in, getting serious from 2013. Luckily for gold bugs, the downswing this time around was only four years.
How uncertain is the world these days?
The lessons of the bearish period 2011 to 2015 seems to be this – sell when it seems like an economic problem is fixed and the world is returning to ‘normal’, buy when ‘uncertainty’ is on the rise, as opposed to the more nebulous ‘trouble’ we talked about above. And if there’s one thing we seem to have more of in 2020 it’s uncertainty. Just about no one I know predicted the Brexit vote in June 2016 or the Trump ascendancy in November 2016. Or the start of last year’s US-China Trade War. Indeed, even the outcome of Australia’s Federal election last May and Britain’s General Election last month seemed to take everyone by surprise. And who saw coming the waves of popular discontent that have rolled around the world in places as diverse as Santiago, Beirut, Hong Kong and Barcelona? To some the world seemed a fairly certain place as recently as five years ago. No longer.
Which brings us to the current bull run for gold that has taken the yellow metal above US$1,500 an ounce and has many people saying that it will head to US$2,000 an ounce in the not too distant future. There’s a lot that’s attractive about that view. 2020 will likely remain a year of heightened uncertainty thanks to the Trade War and Brexit, neither of which is concluded. Central banks, when they aren’t printing fiat currency, have lately been buying a lot of gold (Russia’s central bank routinely buys a fair bit of Russia’s gold output, for example). A lot of the metal outside central bank vaults is held in the Asian region by people of Chinese heritage, so the uncertainty regarding the future of Hong Kong will likely prove a continuing strong point for the metal in 2020. Physical demand for gold in Asia tends to go up close to the Lunar New Year holidays so that might be a near-term factor for gold bugs as 2020 starts.
On the supply side, there are fears that global gold production may be peaking after a long period where new gold mine discoveries have been slowing.
And, who knows, we might see some more inflation in the world this year – on that score it’s worth noting that the Food Price Index, as calculated by the UN’s Food and Agriculture Organisation, soared to a 5-year high in December 2019.
What to watch out for
Which brings us to how investors should invest in gold on the ASX, should they be convinced that the good times for the metal are set to continue. There are two main ways – firstly through established gold producers such as Newcrest or Evolution, and secondly through the emerging gold mine developers that are in a position to report Resource estimates as per the industry standard JORC Code.
The key when evaluating established gold producers is to check their production costs and their selling price as per the hedge book. Gold may be up, but future output of those miners may be sold forward at a level much lower than the price at which the metal has risen to. And some miners may have ‘all-in sustaining costs’ that are high and others that are low. In our experience each mining company is different.
For the emerging developers a good measure is ‘Enterprise Value per Resource Ounce’. For instance, imagine a company with a market capitalisation of A$50m, no debt, A$10m cash and a 2-million-ounce deposit. The Enterprise Value per Resource Ounce of this company is A$20. Obviously, a host of factors come into play in the way the market prices a potential new miner, but, other things being equal, the lower the Enterprise Value per Resource Ounce, the better. Anything under A$20 is likely to be regarded by established resource sector investors as ‘inexpensive’.
Sovereign risk is real for gold miners
A third factor also needs to be looked at for both established and emerging gold miners and that’s location and sovereign risk. A lot of gold comes out of countries that aren’t so easy to operate in as the US, Canada or Australia. The West African country of Mali, for example, is currently emerging as major gold producer, and, while it is known as one of the more mining-friendly jurisdictions in the world, it can also be a dangerous place, as evidenced by active Islamic extremist groups in the mining zones. South African gold projects come with issues around rising costs of electricity and labour. Indonesia has been restructuring environmental and taxation policies, negatively impacting gold projects here. And so on.
Our message for would-be gold bugs is to do their own research and do it thoroughly. We at Pitt Street Research will likely be covering a few gold plays in 2020 and there are other sources out there that can help you check out the sector. Take a look at the presentations from the leading companies available on the ASX website and maybe even invest in a dictionary of geology and other books on mining so you can better understand what you may be getting yourself into.
Most important of all is to be aware of the historic tendency for bear markets in gold to start when people least expect it. The January 1980 high for gold came right when the Soviet Union had invaded Afghanistan. You’d think that would be a positive for gold but after a brief spike it proved a negative. One suspects that the current bull market that started in late 2015 could have a similar sudden ending.
And there’s one more thing to keep in mind. Historically investors only had gold as a portable store of value to hedge against fiat currencies. Nowadays there’s cryptocurrencies like Bitcoin. Possibly the world’s stock of gold bugs to fuel the current bull run is diminished by comparison to 2001-2011. That’s yet another uncertainty to consider in our currently uncertain world.
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