The price of gold increased by 22% in the first seven months of 2020 and significantly outperformed all other major asset classes, recalls analyst Matthew Miller in CFRA Research’s flagship newsletter, The Outlook.
Gold bullion prices averaged $1,404/ounce in 2019, up 11.0% from $1,265/ounce in 2018. In the first half of 2020, the average price was $1,664/ounce. By mid-August, it was $2,035/ounce.
An unprecedented level of negative interest rates across the globe, ongoing trade wars, and heightened uncertainty surrounding the U.S. presidential election will likely continue to support gold demand.
CFRA thinks the price of gold is poised to trade well above its historic high later in 2020 and throughout 2021. Gold hit its all-time high price in August 2011 (the record close is $1,891.90 per ounce, while the intraday record is $1,923.70 per ounce).
Gold’s role as a hedge against inflation is also a major focus now, as major governments continue to stimulate economies with quantitative easing.
Central banks continue to cut interest rates and inject more money into economies that have an insatiable demand for easy money, which should eventually lead to higher inflation. CFRA Research views the current environment as a positive backdrop for gold fundamentals.
Various exchange-traded funds (ETFs) hold a significant number of gold mining stocks; depending on desired exposure to gold miners, investors could choose from VanEck Vectors Gold Miners (GDX), 100% of assets in gold & silver mining stocks; VanEck Vectors Junior Gold Miners (GDXJ), 100% in gold miners; SPDR S&P Metals & Mining (XME), 16% in gold miners; Materials Select Sector SPDR (XLB), 13% in metals & mining stocks; and Vanguard Materials (VAW), 7% in gold miners.
Other ETFs track the price of gold itself, rather than the miners. Such ETFs include SPDR Gold (GLD), Aberdeen Standard Physical Swiss Gold (SGOL), and VanEck Merk Gold (OUNZ).
According to the World Gold Council, holdings of gold-backed ETFs reached a record high in the first quarter of 2020, as the coronavirus pandemic took hold. This trend will likely continue as investors look to hedge against uncertainty and inflation.
Historically, gold has proven to be an excellent store of value and is arguably the best hedge against inflation and stock market volatility.
CFRA has a positive view on gold miners based on the following reasons: the economic cycle continues to mature, asset valuation multiples are expanding, asset bubbles are emerging in certain areas, and budget deficits are increasing at alarming rates, creating the specter of future inflation.
CFRA expects central banks to be the key driver of gold demand in the coming years, primarily due to diversification of reserve risk away from the U.S. dollar. As of the first quarter of 2020, about 62% of the world’s $10.9 trillion allocated foreign exchange reserves were held in U.S. dollars, according to the IMF.
In 2018, central banks demand for gold as a reserve asset rose 73% compared to 2017, the highest central bank buying in 50 years, attributed to geopolitical concerns and the uncertain macroeconomic environment, according to the World Gold Council.
The buying momentum continued through the first three quarters of 2019, rising 12% year-over-year, with central banks in emerging markets contributing most of the growth. However, demand slowed during the fourth quarter, 34% lower YoY versus the fourth quarter of 2018.
According to the World Gold Council, global mined gold production reached 3,534 tonnes of gold in 2019, down from 3,561 tonnes in 2018 – ending 10 straight years of growth.
In May 2018, a leading gold executive claimed the world had reached peak gold—a situation where global gold mine production reached its peak and starts declining – as all major gold deposits have already been discovered.
In fact, 15 of the world’s 20 largest gold miners — including Barrick Gold (GOLD), Newmont (NEM), and Kinross Gold (KGC) — suffered from a decline in their overall remaining years of production (reserve life index) from 2008 to 2017, according to S&P Global Market Intelligence, which further notes the increase in gold exploration budgets over the past decade has failed to produce any significant discoveries.
Spending on gold exploration was at historically high levels in the last 10 years, nearly 60% higher than the preceding 18-year period; however, only 215.5 million ounces of gold have been defined in 41 discoveries, eight times below the 1,726 million ounces of gold in 222 discoveries over the preceding 18 years.
The 2016 launch of the Shari’ah Standard on Gold, which provides definitive guidance on gold products for Muslim markets, is expected to boost gold demand.
The size of Shari’ah-compliant assets under management are projected to reach $6.5 trillion by 2020, with a 1% allocation to gold amounting to 1.9 thousand tonnes or $65 billion of new demand, according to the Islamic Finance Stability Board.
The World Gold Council classifies gold demand into four categories: jewelry, technology, investment (e.g., ETFs), and central bank net purchases. Given these classifications, gold’s supply and demand dynamics are not as straightforward as the other asset classes.
Gold prices are influenced by macroeconomic factors in the U.S. and other world economies, performance of alternative assets such as equity and bonds, the value of the dollar, interest rates, and inflation. Investors hold gold in their portfolios as an inflation hedge.
Investors also value gold in their portfolios when there is elevated uncertainty or enhanced event risk. For example, gold prices experienced a meaningful appreciation following the Brexit announcement (Britain’s decision to withdraw from the European Union in June 2016).
CFRA thinks the all-stock merger between Barrick Gold and Randgold Resources, completed in early January 2019, was only the beginning of a new wave of M&A in the gold space, as gold miners look to add reserves in anticipation of another major gold bull market.
The $6 billion deal has made Barrick, already the world’s largest gold miner prior to the merger, even bigger. As a company grows annual production, the addition to reserves must increase at the same rate to keep a company’s average mine life constant.
We forecast some of the largest miners might shift their attention to opportunistic acquisitions (targeting firms trading at discounts to P/NAV that can be accretive to both the size and quality of reserves). On May 11, 2020, SSR Mining (SSRM) announced an all-stock acquisition of Alacer Gold for $1.72 billion.
The combined enterprise will have a market capitalization of approximately $4.0 billion and is expected to generate peer leading average annual pro forma free cash flow of $450 million (2020E- 2022E), well ahead of a peer group annual average of $275 million based on consensus estimates.
On July 1, 2019, Barrick and NEM concluded a joint venture transaction forming Nevada Gold Mines (NGM), a combination of both their gold mining operations in Nevada. NGM is the largest global gold producing complex, with total proven and probable reserves of more than 48.3 million ounces. NGM is 61.5% owned and operated by Barrick, while NEM owns the balance.
Barrick Gold, Kinross Gold, and Newmont discussed above, as well as Franco-Nevada (FNV) and Royal Gold (RGLD) earn CFRA’s 4-STAR buy rating. Agnico Eagle Mines (AEM) and Wheaton Precious Metals (WPM) earn our 5-STAR — or strong buy — rating.
