Gold: America’s Financial Hegemony
Is Not Sustainable
By John R. Ing
President and CEO,
Maison Placements Canada Inc.
This is an edited version of an article, Gold: A Legacy of Debt, Deficits and Doom, that appears on The Bull & Bear’s website, www.TheBullandBear.com.
To be sure after a decade of record stock market gains and IPO unicorns, the world’s central banks should be threatening to pull the punch bowl away. However the December market collapse was the worst on record as the stock market vigilantes took matters into their own hands, causing the Fed and other central banks to execute a U-turn, putting interest rates on hold which drove markets again to new record levels.
However, if December was anything, it was a wake-up call. For too long the United States have mismanaged its finances, consuming more than they are producing. We also believe that America’s established control over global finance and weaponization of sanctions threatens America’s central role in world’s financial markets.
With more than $10 trillion of bonds showing negative yields, fears of deflation are growing. Like the Thirties, investors are paying also for the privilege to park their money and if held to redemption, would lose money. Noteworthy was during the Dirty Thirties, gold was a hedge against deflation, acting as a store of value, whilst asset prices plummeted in a deflationary spiral.
We believe that the Trump-inspired trade wars, an unpredictable presidency together with the weaponization of American financial hegemony has in large part forced investors to look for alternatives. The dollar’s global role gives America the means to impose financial sanctions to great effect. It can exclude countries from the dollar based international payments system. Trump’s populist approach whilst thumbing his nose at foreign investors has resulted in a weakening view of the US dollar. Although there are few alternatives, America’s financial hegemony is simply not sustainable. Gold is a hedge against that.
The US is not dissimilar to an emerging market economy where their balance of payments is as terrible as their fiscal debt. Today, the greenback has run into resistance on fears of a protracted trade war and an inverted yield curve. Geopolitics is playing a greater part here. As the global repercussion spreads, America depends on the very countries that it labels a security risk to finance their consumption – how naïve and dangerous.
On that point, our view is that the Fed has reached the limits of its abilities with a balance sheet which represents more than 25 percent of US GDP. With one third of America’s debt financed by outsiders, an inverted yield curve has encouraged investors to look elsewhere. We believe that the US financial hegemony and deteriorating financial status has jeopardized the dollar’s reserve status and we are near that point of inflection where like Great Britain before, creditors will balk at financing US obligations.
Gold Has Become Money Again
Fittingly, gold is an alternative to the dollar. In the past, it has been a protector or hedge against the debasement of currency, because it is less susceptible to government manipulation. Last year, central banks purchased a near record 23 million ounces, becoming the world’s largest buyer, adding to their reserves at the highest pace in 50 years. Central banks keep dollars in reserve but under the new Basel III standard, gold has taken on more importance and can be today valued the same as dollars. Basel III returns gold as a meaningful reserve asset whereby, gold is now risk weighted as a Tier I asset as part of total reserves. Thus, gold reserves held on central banks’ balance sheet can be valued at 100 percent allowing them to increase their liquidity and revalue their balance sheets upward. Gold has become money again.
In total, governments added 652 tonnes in 2018, the second highest total on record, according to the World Gold Council. They see gold as an alternative to the dollar. China has been on a gold buying spree, recently purchasing gold again for the past four months, laying a foundation of gold in their $3.1 trillion reserve stockpile. China is the world’s largest consumer of gold and must import gold to satisfy domestic demands. China is also the world’s largest creditor and their gold holdings make them less dependant on the dollar, particularly since the United States has weaponised the dollar. Other countries are diversifying with Saudi Arabia considering dropping the petrodollar and even threatening to dump their stockpile of treasuries should Congress lift sovereign immunity from US antitrust laws (NOPEC). Russia has already replaced the dollar with gold, dumping all their US debt, purchasing one third of the world’s gold supplies last year. They have tripled their reserves over the past decade as a counter to the US dollar dominance and hold 2,163 tonnes of gold.
Russia and China have become the fifth and sixth largest gold holders in the world, rivaling America which has the largest stockpile at 8,000 tonnes. The risk for America is that China too dumps its dollar holdings which would create problems for the US government’s financing plans, and the dollar itself. Remember the Golden Rule: “Whoever has the gold makes the rules.”
We believe that investors remain too complacent, unwilling and unable to fathom the magnitude of the problem. The unsustainable is no longer sustainable. We also believe that when “informed insiders” such as the world’s central banks buy gold at the highest pace in fifty years and the gold miners buy each other, that gold must be a screaming buy. Compared with stocks and other financial assets, gold is inexpensive. Gold is like Marie Kondo, the neat freak. However, unlike the decluttering guru, gold’s real joy is its traditional store of value. It is a good thing to have.
Like a game of musical chairs, investors are speculating as to whom is next in the latest round of mergers and acquisitions (M&A) in the Canadian gold mining scene. So far, in the first half of this year, about $18 billion worth of M&A activity has taken place led by Barrick's acquisition of Randgold and Newmont’s acquisition of Goldcorp. Suffocating from lack of growth, the mid-tier gold companies are looking at each other as to whether a merger would bring long promised efficiencies and offset the depletion of gold reserves. After four years of reserve declines and big writedowns, performance-minded institutional investors are frustrated by the mid-tiers’ higher G&A costs and are pushing for further consolidations. The dilemma for these producers is that any combination might not necessarily be complementary and lack the synergies of say Barrick and Randgold who possessed complementary assets. Instead they are facing “peak gold” conditions with slashed exploration budgets as a cost saving move but still, producers have “all in costs” at more than $1200 per ounce, ensuring future losses.
With few discoveries then, some of the mid-tiers are eyeing the unwanted assets from the Barrick and Newmont blockbuster mergers. It is telling that the gold miners believe that the stock prices today are attractive enough that the ounces on Bay Street are cheaper than spending scarce funds on exploration. Thus, the recent deal making is expected to continue. New players from South Africa, Australia and China are expected to join the competition for assets. To be sure, there will be a trickle-down effect as the majors spinoff non-core assets. However, we believe that many mid-tier companies would be better off looking to acquire development assets rather than merge with their counterparts as the industry is still chastened by the huge multibillion- dollar writedowns of past mergers and acquisitions. Investors wisely no longer blindly support these acquisitions. Capital remains so scarce that liquidity will become important. We thus continue to like Barrick Gold, Agnico Eagle or B2Gold. Agnico Eagle will have record production this year as two mines come on stream.
• B2Gold Corp. (BTG) – B2Gold beat forecasts with another strong quarter with contributions from Fekola in Mali providing 110,000 ounces. Masbate, Otjikoto and El Limon did better than expected. B2Gold has unveiled a $50 million expansion at newly opened Fekola North making the open pit, B2Gold’s largest producer. Newly commissioned Fekola is expected to produce 420,000 ounces at an AISC of $650 an ounce. Last year, B2Gold produced 950,000 ounces with guidance increasing to 970,000 ounce this year. With five mines operating, B2Gold was able to pay down debt. We continue to recommend B2Gold for their rising production profile, a pipeline of potential producers (Gramalote jv, El Limon expansion) and a management known for execution.
• Barrick Gold Corp. (ABX) – After unveiling an unsolicited, hostile, and no premium $18 billion bid for Newmont, Barrick and Newmont reached an agreement to merge their Nevada operations in a joint venture that will produce some $500 million of synergies over the next 5 years. The joint venture becomes one of the world’s third biggest gold producer, with a combined output of 4 million ounces and about 48 million ounces of reserves. Barrick will be the operator with a 61.5 percent interest and Newmont Goldcorp will hold a 38.5 percent stake. Newmont contributed processing facilities as well as mines. The Nevada operation will contain four Tier 1 mines (more than 10 year mine life) and adds about $1.00 to Barrick’s NAV. We like the deal since it allows Barrick to build up a core asset without having to spend a billion for a roaster. The joint venture efficiently consolidates a mining camp under one roof. Barrick has become the “go-to” miner. Buy.
• Detour Gold Corp. (DGC) – Detour, a mid-tier Canadian producer, reported production in line with guidance but noteworthy was that the Zone 58 N development scoping study was put off into the future. Mining rates topped 315,000 tpd in the December quarter but head grade remains low. Simply, Detour loses money with every ounce they produce because of an all in cost of $1,200 an ounce. Needed is for the mine to go underground to chase better grades. We prefer Agnico-Eagle here.
• Eldorado Gold Corp. (ELD) – Eldorado wisely changed the Kisladag mine plan in Turkey by resuming mining and heap leaching, and, shelved the $500 million milling project which would have sapped their balance sheet with little returns. The Lamaque mine in Quebec achieved commercial production and will produce 100,000 ounces this year. Olympias in Greece will produce about 50,000 ounces but there is little news on the permitting standoff in Greece with regard to Eldorado’s other Greek assets. Eldorado should produce about 400,000 ounces this year reflecting Lamaque and the continued contribution from Kisladag. Eldorado has about 24 million reserves but faces a whopping debt repayment in 2020. While we are positive on Eldorado’s latest moves, the company’s mines still do not generate sufficient cash flow to pay down that debt. We prefer B2Gold here.
• Kirkland Lake Gold Ltd. (KL) – Kirkland Lake Gold had a strong first quarter led by production increases from the high grade Fosterville mine in Australia and Macassa. The increase was above analysts’ forecasts ensuring they will meet guidance of 950,000 ounces due to stronger output from Fosterville’s high grade Swan Zone. Mineral reserves increased 24 percent to almost 5.7 million ounces at high grade 15.8 gpt. Kirkland Lake has a strong balance sheet of $410 million of cash and no debt. Since Kirkland Lake trades at a healthy premium to its peers, we would not be surprised if the Company became an acquirer, using its richly valued paper to boost a short reserve life.
• Newmont Goldcorp Corporation (NGT) – Newmont successfully acquired Goldcorp boosting annual output to almost 7 million ounces making Newmont Goldcorp, the world’s largest gold producer. The combined company will have a strong balance sheet and the acquisition of Goldcorp gives it a pipeline of potential projects. However, we believe that Newmont will be a pruner of assets rather than a builder because they must tackle underperforming Eleanore in Quebec disappointing Coffee, and finance the maturing Porcupine and Red Lake mines. In Mexico, Goldcorp’s former flagship, Penasquito which produced almost 300,000 ounces was shutdown temporarily by Newmont because of a labour dispute. Importantly none of the above will replace the assets vended into the 38.5 percent Barrick joint venture. In addition, CEO Gary Goldberg retires at the end of this year, leaving Tom Palmer, a former RIO executive to sort out Goldcorp's problems. Interesting is that rival partner, Barrick has agreed to a standstill agreement of only two years, giving Barrick ample opportunity to watch Newmont do the heavy lifting to workout Goldcorp's problems before an encore bid. We prefer Barrick in the interim.
• Yamana Gold Inc. (YRI) – Yamana finally bit the bullet and sold the Chapada copper/gold mine in Brazil to Lundin Mining for over a billion dollars. Yamana will receive $800 million in cash and additional payments of $225 million. The sale was expected and although at the lower end valuation, Yamana will apply the proceeds to reduce its whopping $1.76 billion of debt. However Yamana will be left with a flat production profile without Chapada. Nonetheless, we remain concerned about Yamana’s balance sheet, and high G&A cost profile. We prefer B2Gold here.
Editor’s Note: John Ing is President & CEO of Maison Placements Canada Inc. Mr. Ing has over 45 years of experience as a portfolio manager, mining analyst and investment banker.
Maison Placements Canada Inc. is an institutional investment boutique that provides financial services to corporate, government, institutional, and individual investors. The firm offers securities underwriting, distribution, and execution services. Additionally, it provides investment banking services including mergers, acquisitions, and divestures; equity financing; financial and corporate restructuring; valuations; fairness and regulatory opinions; and management advisory. For more information on Maison Placements Canada, visit www.maisonplacements.com.
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