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Gold: The Total Eclipse of Donald Trump

By John Ing, President & CEO
Maison Placements Canada Inc

The tumultuous sound around Mr. Trump has shown that his self-destructive behavior has drowned out his message and as it builds to a crescendo, could even affect his presidency. Mr. Trump has been consistently vindictive, narcissistic, schizophrenic and, despite the talent around him, continues to play the lone wolf. The businessmen turned president “fired” his Business Council before the CEOs and bankers were to quit in protest to his Charlottesville race comments, tarnishing the president’s pro-business credentials. In the nine months of his presidency it has been all about Trump, forgetting that it should be about America. The president’s personal preoccupations keep shooting himself in the foot, like scrapping TPP without concessions and handing over needed political leverage to his opponents. Maybe he should reread his “Art of the Deal”?

They passed legislation to stop Trump from lifting sanctions on Russia. They fought back his plans to ban transgender Americans from the military. They even defeated a skinny version of repealing ObamaCare. An emboldened Democratic party? No. Instead it is the Republican lawmakers who, so frustrated with their leader are openly defying his wishes. Senator Ben Sasse (R-Neb) barked, “The Presidency isn’t a bull, and this country isn’t a China shop.” Noteworthy, however that Trump did manage what few presidents before him could, win a major victory in the United Nations. Russia and China, frequent dissenters joined the US in an unanimous approval of sanctions against, North Korea. Beijing, Moscow, Pyongyang and Tokyo have been sucked into this war of words. But victories are few. At home the deadly violence in Virginia sparked a backlash giving the Deep State more ammunition. His White House is in a state of open civil war and chaos. His poll numbers keep falling, his isolation grows. Trump is somehow unwittingly dividing and losing, not conquering. Trump has even made gold great again.

American Profligacy and The US Dollar

The US dollar has been losing ground and is even lower than when Trump took office, ironically peaking when he said the dollar was too strong. Today he is getting what he wished for. The US dollar has become the worst currency in the world, collapsing due in part to his failure to pass the Healthcare Bill raising doubts whether he can get Congress to approve tax reform which is equally divisive. In addition, the market’s reaction to the Washington gridlock and the daily circus in the White House has eroded confidence in his administration and the US dollar. Then there are the dovish statements from the Federal Reserve which left investors wondering whether a September rate rise is in the offing. Worse, Fed Chair Janet Yellen recently mused that, “I don’t believe we will see another crisis in our lifetime”, ignoring her role in the last Fed-fuelled crisis bubble that burst. To be sure, the upcoming “debt mess” discussions and Trump’s shutdown threat adds fuel to the fire.

Trump’s dueling threats with North Korea raised even more questions but the prospect of a trade action against Beijing, America's major trading partner has renewed concerns about a major trade war hurting both nations. The debates on trade has caused factional battles within the White House which has not helped confidence in the dollar or the Trump administration. The sinking dollar it seems is simply a reflection of Trump’s fortunes, exacerbated by the “fire and fury” threat which helped push gold to more than a 12 percent gain this year, outperforming most markets.

Today other than immediately after World War II, the United States debt is at the highest ever. Borrowing beyond its means for over a half century, Americans became adept at spending tomorrow’s money. With the US dollar becoming the cornerstone of the global financial system, it has become the world’s biggest borrower, dependant upon foreign nations to finance its profligacy. However, this time, Donald Trump’s promised disruptive change might cause conflicts with its creditors, some of whom are in his crosshairs as “currency manipulators”. America’s creditors which financed over half of its debt have leverage to push back and will not overlook the world’s biggest deficits and surge in spending. The world has never witnessed the present levels of debt. Remember that when Congress must increase the debt ceiling and pass the budget this fall. The United States runs out of money in October.

As pessimism spreads about the financial viability of his economic agenda and starved for a legislative victory, Trump and his team may yet elevate the gold standard discussion which has become an issue among some Wall Street and hedge fund supporters of Trump. Such a move would make for smart politics, as well as smart policy because it would limit the power of the Federal Reserve and government’s penchant to spend. Then again if the status quo remains, gold might continue to be an effective hedge on concerns that the political drama in Washington will eventually impair the government’s ability to function, weighing ever more heavily on the overvalued financial markets.

Debt Trap – A Time Bomb

Against this background, bonds and stocks are overly expensive, inflated by a decade of extraordinary stimulus measures, as trillions of newly minted dollars were created to drive down interest rates to save the banking system. As a result, central banks own a fifth of government total debt and their balance sheets are four times pre-crisis levels. The Fed alone has a $4.5 trillion balance sheet built up by quantitative easing. To be sure, any attempts to “normalize” or reduce the bloated balance sheets by allowing securities to mature or the reinvestment of maturing bonds raises the possibility of massive sales into a market that is ill-prepared to absorb it. Never in monetary history have we had a prolonged period of negative rates. We are in unchartered waters. QE economics have lulled markets into a false sense of security on debt sustainability. After Jackson Hole, expect bond yields to resume their upward trajectory. Moreover, reducing these balance sheets has many consequences.

The entire financial ecosystem has been compromised by a decade of central bank experiments. Bond yields are significantly lower than any possible time value discount giving rise to imbalances and distortions. There is no discipline in the system. Economic theory again shows that it is inevitable that interest rates will rise. Indeed, we have had four rate increases, but in measurable movements. The time value of money and history shows that the ‘normalized” level is perhaps at least double or triple current rates. When that occurs, as inevitable as King Canute’s tide, the massive loss of wealth will be yet another problem that Trump and friends must deal with.

United States is Too Big to Fail

Wall Street has again created and sold new structural products like ETFs, only 10 years after their last creations such as collateralised debt obligations or credit default swaps almost blew up the financial system. The world of exchange traded funds has exploded in size. Today the record breaking inflows into exchange traded funds (ETFs) are fueling fears of over-crowding and that the tide of money is helping to inflate the stock market bubble. We believe Wall Street’s ETFs have emerged as a new asset class and the management of assets “by wire” or passive investment threatens to become the next asset of mass destruction. ETFs give an illusion of liquidity, but when the $5 billion VanEck’s Junior Gold Mines GDXJ became too big, it faced a structural problem that required a reconfiguration and share consolidation of juniors. Liquidity was an illusion since a restructuring of the portfolio took months to achieve. ETFs have not incorporated the risk that many different participants, follow the same fashion and choose to take positions in the same vehicle in a herd-like manner, the outcome could end badly. Lessons haven’t been learned. Déjà vu.

Risk has also shifted ironically from the private sector to government only a decade after taxpayers bailed out Wall Street and its banks. Amazingly though, it is not the private sector that is exposed, but the government sector with sovereign debt in some cases yielding comparable to junk bonds. Italian junk bonds today yield less than US Treasury units which are supposed to be risk free. No one asks will this debt ever be repaid. History shows that sovereign debt defaults are only too common. There were of course the sovereign debt defaults in the Thirties and in the Eighties, we had the global debt crisis. Argentina has defaulted on its debt six times in the last century. We had defaults in Russia, Asia and Mexico in the Nineties. Debt on debt is not good. Then there is the debt on central banks’ balance sheets at record highs with four of the biggest central banks holding more debt than America’s annual GDP. America’s debt today stands at $20 trillion.

The problem is that this mammoth debt load endangers the global financial system. Central banks are part of the problem. The debt clogged system is poised to burst. And today, amid America’s drift towards fiscal instability, compounded by economic nationalism and protectionist measures, something simple like a botched debt ceiling discussion could swamp the financial system in a nanosecond.

Money itself has come into question. Just ten years ago, banks in London, France and United States were forced to have “bank holidays” as money became a paper credit or IOU after a run on the huge money market funds threatened to paralyse the global banking system. Those funds held mortgages which were cut and diced into derivative tidbits that were found to be worthless. Also those banks were considered too big to fail, such that the government spent trillions to prop up the system. Today sovereign governments are considered too big to fail. But the bailouts of Greece, Iceland and Ireland are lead indicators of the growing conflict and risk. The current political and social meltdown is a symptom that the bubbles created by fiat money and consequent debt issuances cheapens money, increasing risk. Rates are negative, bond buyers remain complacent and central banks, despite rhetoric, remain easy. We thus believe that the dollar is falling, not because the Fed is “tight” but trust in the US has been damaged, which damages the entire world. There was a time when gold was money. In today’s uncertain world, we are not surprised that the yellow metal is back in fashion.

Where Is Inflation?

Despite the printing of trillions of dollars (QE1, QE2, and QE3) over the last eight years, central banks are frustrated over chronically low inflation, though the absence does allow them to keep credit loose. Past history showed that if you printed too much money, that money chased too few goods resulting in higher inflation. Yet another month, another low inflation number. What gives? It is too early to celebrate. In the 60s, 70s, and 80s, inflation was a product of too much money chasing too few goods and for a time – hyperinflation emerged in some countries like Russia, Zimbabwe or Venezuela.

Today trillions of dollars are sitting on the balance sheets of the central banks’ surrogates, the investment banks and commercial banks which have held onto those reserves partly to repay for the sins of the past. That money however fueled bubbles in the stock market and real estate, because of the nominal carrying cost. We believe that after three attempts of experimental quantitative easing, the central bankers and politicians will fall back to their default position of blatant money printing, commonly called “helicopter money”, perhaps in the form of tax cuts where the handouts are this time distributed directly to Main Street rather than the Wall Street bankers. And in unwinding their portfolios, central banks might find it politically expedient to just let the money flow into the economy. The sums are huge which could then lead to very high inflation. That is something that the markets have not discounted.

Another reason for this apparent lack of headline inflation is demographic. Having bought homes, raised children and with multiple cars sitting in the garage, the Baby Boomers have been saving for retirement rather than consume and spend. But when they spend, they rack up cheap debt.

During the Seventies, trillions were used to finance President Johnson’s social spending programs and fight a war resulting in big handouts to the American people. The Baby Boomers took that money and spent resulting in double-digit inflation and Fed Chair Volcker’s bitter double digit medicine. According to the NY Fed, today household debt is at $13 trillion having surpassed the previous peak of the 2007 bubble. After bingeing on credit, using debt to subsidize spending, credit card debt, too hit an all-time peak. Ominously both the Great Recession and Great Depression were preceded by similar run-ups in household debt. In fact, margin debt so far has set four new peaks this year which is an increase of 64 percent from the margin levels of January 2008, the year of the crash.

Gold Is an Investment in Monetary Disorder

Gold is a barometer of investor anxiety, a storehouse of value and in time, a hedge against inflation. In recent days, gold has spiked through $1,300, still shy of the $1,940 an ounce high reached in 2011. Like all commodities, gold is subject to supply and demand but steady purchases by major central banks including China and Russia have sopped up physical supplies. We believe the purchases are tied to the expectation that the US, Japan and Western Europe have public debt trajectories that are unsustainable.

This year gold has risen 12 percent. While the consequences of the series of quantitative easing has not been evident, we believe the era has come to an end, drowned beneath the rising tide of overvalued assets. If holding the barbaric metal is irrational, where then is the rationality in dedicating 100 percent to paper assets which are inherently unstable?

And inflation is back. There already is a first wave of inflation in hard assets, the stock markets, real estate and vanilla beans because of the abnormally low carry costs. That flood of money has supported another tech bubble with trillion dollar entities resulting in lofty valuations and a herd-like investor greed not to be the last one standing. However, cost pressures are in the offing from wages to energy, and of course depreciating currencies. As such when inflation returns to Main Street, we believe that impetus will push gold to $1,400 an ounce and then $2,200 within 18 months.

Industry Comment

The lack of gold discoveries has prompted M&A activity. Depleting reserves are a problem for the gold industry as the industry will mark six straight years of declining reserves. At the same time, China the No.1 gold producer, is on the hunt for new reserves because its gold miners have short mine lives. Many Chinese producers will run out of reserves by 2020.

Investors have shunned gold stocks, preferring ETFs for exposure. Optimism about the mining industry however is largely confined to themselves. Producers, after fixing their balance sheets today make more money mining one ounce of gold than they made five years ago. Costs have been slashed by 20 percent. We believe the long awaited turnaround will be evident once gold adds another $100 or so at which time those reserves in the ground become extremely profitable to mine. Then, the retail investor will return. And because of declining grades, hostile local governments and the lack of drill hole successes, there is so little physical supplies compared to growing demand.

But there are signs of life. Novo Resources has shot up almost 400 percent in the past six months on hopes that its Australian open pit gold project is comparable to the big South African Witwatersand. Drilling will confirm or disprove this theory but Newmont is keenly interested. At home, Rob McEwen has acquired the Black Fox mill and property for a paltry $35 million from hard luck Primero becoming a major player in the Timmins camp. Finally, we helped, Keith Barron raise $6.2 million for Aurania hoping he can emulate his success in finding another billion dollar Fruta Del Norte in Ecuador.

Consequently, among the large cap producers we like Barrick Gold and Agnico Eagle. We do like the growth oriented B2Gold and junior growth story McEwen Gold. Replacing declining gold reserves is the industry’s Achilles Heel – the above companies are trying to fix the problem.

Agnico Eagle Mines Limited (AEM) – Agnico Eagle’s strong performance reflects the successful execution of bringing on its mines without drama. Agnico Eagle reported a strong quarter and raised guidance due to a better performance from the Meadowbank and Malartic mines benefitted from improved grades and higher throughput. Of note is that Agnico Eagle’s excess cash flow resulted in a balance sheet of almost a billion dollars which is needed since they plan to spend $860 million in drilling underground development at Meliadine where engineering is 80 percent complete and, extend Lapa’s mine life. Flagship LaRonde’s grade was also better at 1.11 gpt and studies have begun to develop lower sections, ultimately below three kilometres underground. Meantime, Agnico Eagle plans public hearings at Amaruq in Nunavut towards year-end. Permitting should be completed by the third quarter 2018 and production is expected from the Amaruq satellite zone by the third quarter 2019. The Whale Tail deposit has been defined over a strike length of 2.3 km to a depth of over 700 m, remaining open and along strike. Consequently, we believe Agnico Eagle will achieve its production target of 2 million ounces by 2020. We continued to recommend the shares here.

Barrick Gold Corp. (ABX) – Barrick Gold had excellent results. The company completed the sale of 50 percent of Veladero to Shandong Gold, a state owned Chinese company which also includes the joint development of one of the world’s largest gold and silver deposits, Pascua-Lama which was beset by technical and cost overruns. Barrick’s Nevada core assets resulted in second quarter production of 741,000 ounces after putting together the huge Cortez complex with Goldstrike. Costs were an industry low of $541 per ounce. Of interest is that underground automation was aided by the innovative digital programme as Barrick digitized scheduled maintenance work and operations bringing Barrick into the 21st century. Barrick is a leader here and digitization will contribute to lower Barrick’s AISC to under $800 an ounce. Cost reduction remains a priority and Barrick’s asset sales and improved operating margins will allow it to slash debt from $13 billion to $5 billion next year despite a flat production profile. Barrick has optimized its portfolio emphasizing organic growth and new production in the future will come from Nevada-based Goldrush and Alturas for example.

At this time 64 percent owned Acacia is an unknown but the impact is only about 10 percent of Barrick's production. Acacia is still operating its mine and stockpiling concentrates with some 127,000 ounces of gold and concentrate currently stored. However, the Government of Tanzania has slapped a whopping tax bill of $190 billion or 190 times revenues in a nationalistic move prolonging the lengthy dispute. Barrick has begun direct discussions with the government led by John Thornton amid hopes that Barrick will not have to turn off the lights, if they are forced to leave Tanzania. Barrick is the world's largest gold producer with some 12 operating mines and will produce about 5.5 million ounces this year. We like the shares here as a core holding with the largest in situ reserves in the world at 86 million ounces. Buy.

B2Gold Corp. (BTO) – B2Gold produced 133,000 ounces in the quarter which was 8,000 ounces or so better than budget led by Otjikito in Namibia and Masbate in the Philippines. Otjikito produced 43,000 ounces due to better grades. On the other hand, the maturing Nicaraguan mines, La Libertad and El Limon were on budget. Helped by lower costs at Otjikito at $413 an ounce, B2Gold’s overall AISC was $889 an ounce which is positive for a mid-cap producer. The Fekola development project in Mali is on budget and 90 percent completed with production targeted in October. Fekola is three months ahead of schedule. Moreover, B2Gold is also spending $53 million on exploration with an emphasis on West Africa where $27 million will be spent. For example, in Mali, B2Gold has three drills turning plus one air core drill, where they are delineating a satellite target. In Burkina Faso they have two drills turning. We continue to like B2Gold for its low-cost operations, strong balance sheet and rising production profile next year. B2Gold is a fast growing mid-cap producer known for steady execution and strong management. Buy.

Detour Gold Corp. (DGC) – Detour Gold had a strong quarter producing 141,000 ounces at an all in cost of $1,123 an ounce which is at the higher end of its peers. Throughput however was a record. Detour refinanced a new $500 million bank facility which will allow it to retire $300 million of convertible debt as well as lower carrying costs. Detour plans a resource estimate at yearend which will be the basis for hopefully another mine design as the West Detour plan was shelved. Noteworthy is the addition of two additional trucks in the quarter and by yearend they will have seven shovels and some 134 trucks which should aid results and efficiencies. Production in the quarter of 150,000 ounces was ahead of schedule due to the additions to the mining fleet. Guidance however was unchanged between 550,000 and 600,000 ounces. Detour is a low grade producer but has potential to be a much bigger entity under higher prices. We believe Detour is a good option on the gold price.

Eldorado Gold Corp. (ELD) – Eldorado’s shares were slashed almost 50 percent, after disclosing lower guidance on next year’s output. Eldorado’s second quarter results were in line with estimates however the company surprised analysts by announcing a one-year delay at Skouries in Greece with a production targeted a year later to 2020 due to a delays of construction related permits by the Greek government. The Greek government has given notice of arbitration over environmental regulations at Skouries and Olympias so the licensing delays the project further. Olympias is a gold, silver, zinc and lead plant currently operating at 60 percent of capacity but should be in full production by yearend. While Eldorado already operates Stratoni in the north, Eldorado’s continuing permitting problems in Greece has disappointed investors who fear that this multi-billion-dollar effort will be for naught.

On the other hand, the balance sheet remains strong with almost $1 billion of liquidity, not bad for a company with a $2 billion market cap. Also, the changeover from Paul Wright to newly appointed CEO George Burns appears seamless but other changes are likely. Eldorado was also hurt by the premium price paid for Integra Gold which is more of an early stage development project and in need of a pre-feasibility study, not expected until next year at the earliest. In Turkey at Kisladag, Eldorado’s flagship mine produced 38,500 ounces in the quarter which was lower than budget, although costs were only $464 an ounce. Eldorado's other Turkish mine, Efemkukuru turned in a strong quarter producing 23,000 ounces. Given Eldorado’s strong balance sheet, George Burns bumpy start, and the fact that Eldorado has lost almost 50 percent of its market cap, we think the shares here have adequately discounted the above problems and could be bought for recovery.

Goldcorp Inc. (G) – Goldcorp’s results were a mixed bag as the company is still mired in a major reorganization. David Garofalo’s task is monumental since Goldcorp needs a radical shift, not a tweak. Goldcorp had a “bet the farm” acquisition strategy and now those chickens are coming home to roost. Goldcorp did produce 635,000 ounces in the quarter at an AISC of $800 an ounce. However, decreased grades at Penasquito in Mexico, its former flagship and ongoing problems at Eleonore in Quebec continues to hurt results heavily. At Borden in Ontario, Goldcorp has begun ramp development in an effort to salvage and produce at least a pre-feasibility study. Similarly, Timmins is in need of a pre-feasibility study which is not expected until yearend 2018. “Ditto” for Cochenour. So much money and so little results here. Patience it seems is needed to salvage prior management’s mistakes.

Meantime after spending half a billion to purchase the Coffee Gold project in the Yukon, Goldcorp is reviewing and optimizing a feasibility study and first production is not expected until 2021 at the earliest. Goldcorp is testing the oxide mineralization but it is still early-stage. Coffee was yet another big bet and consultations will take time (19,000 documents were filed). At Cochenour in the Red Lake District, the exploration focus is trying to understand the orebody but more time is needed. Similarly, at the Century project in the Porcupine district, the company remains evaluating. Updates are few from the multibillion-dollar bet Eleonore which was to be the newest flagship with the project now delayed, due to a new geological interpretation and reassessment. Eleonore meantime has lagged in mine tonnage and further tweaking to operations is needed. In other words, a lot of technical work is still needed. At Penasquito, throughput was down as the company reached the bottom of the pit. Grade is only 0.53 gpt making it difficult to make money at that low grade. Of concern is that in the future, the continuation of big bets and “swing for the fence” moves like newly acquired Cerro Casales and Caspiche gold project, increases operational risk plus stretches the balance sheet despite a 50/50 joint venture with Barrick. We would use the shares as a source of funds here, whilst Garofalo prunes Goldcorp’s costly portfolio.

Newmont Mining (NEM) – Newmont recorded excellent results and recently purchased 20 percent of Continental Gold for $100 million, a development prospect in Columbia in the quest for more reserves. Newmont’s second quarter EBITDA was nearly $700 million for a 60 percent increase with AISC below $900 an ounce. Newmont increased its guidance slightly to 5-5.4 million ounces and plans to spend almost $900 million this year. Newmont is a cash flow machine and for time was harvesting its assets. Newmont's project pipeline has improved including the Twin Creek underground in Nevada, whose underground production will contribute to results next year. Newmont has four core areas with 70 percent of the production located in the United States and Australia. Newmont’s Nevada core assets have become major contributors with higher throughput from Twin Creek and Long Canyon. Twin Creek benefited from the optimization of blends and a Turquoise Ridge. At Yanacocha in South America, dilution due to extreme rain impacted leach recoveries. And at Boddington in Australia, mother nature also interfered with the worst storm seen in 100 years, but operations are back to normal.

Newmont has a gold price linked dividend and with net debt of only $1.5 billion, the company was able to repay $500 million of convertible debt and has room to make a one-time payment to shareholders. Newmont’s dividend policy will likely increase with a $3 billion cash hoard and improving results make Newmont an attractive hold here. Newmont is the world's second-largest gold company by production with reserves of 73 million ounces. Hold.

New Gold Inc. (NGD) – New Gold’s production in the quarter was about 100,000 ounces which was above estimates due to Mesquite in the U.S., Peak in Australia and New Afton in BC. Noteworthy is that construction at problem-prone Rainy River in Ontario is 85 percent complete. New Gold recently changed management in order to focus on the completion of the Rainy River development which is over budget and late. Guidance remains between 380,000 - 430,000 ounces at an all in cost of under $800 an ounce. New Gold is still waiting for the last environmental permit requiring the construction of a temporary tailings facility. While Rainy River is scheduled for start up in mid- September, we expect slippage. New Gold has slightly under $200 million of cash and $174 million is available on an undrawn revolver to complete construction. In the interim, New Gold has initiated a process to sell short lived mine Peak Mine which produced about 50,000 ounces from residual leaching in the first half, to focus on North America and raise funds because the balance sheet is tight. To date so much money has been spent with so little results. We would avoid the shares.

Yamana Gold Inc. (YRI) – Yamana had a strong quarter producing almost 245,000 ounces due in part to a record quarter at Canadian Malartic. However, Yamana’s cash flow was again negative and the company was fortunate to spin a part of Brio which is still losing money. Yamana’s problem is that they have a whopping $1.6 billion of debt in part due to the purchase of 50 percent of Canadian Malartic. Yamana operates six mines at all in cost of under $900 a quarter which includes copper by-products but debt reduction dominates its plans. At Cerro Moro in Argentina, production is expected to begin production in 2018 which will help output but not enough to make a major dent on debt. Of concern, Yamana will need to retire $75 million next year and a whopping $488 million the year after. Sell.

Editor’s Note: John Ing is President, CEO and gold analyst at 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 recognized for providing the highest quality research for emerging growth companies with an emphasis on in-depth analysis instead of the quick synopsis in vogue today. For more information visit www.maisonplacements.com.


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