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Gold: Not a World War but a World at War

This Special Report was prepared by John R. Ing, President and CEO, Maison Placements Canada Inc., one of Bay Street’s oldest financial firms.

Happy days are here again as stock markets staged a Christmas rally declaring victory on winning the war on inflation, after Fed Chair Jerome Powell’s monetary pivot raised hopes that the Fed might cut rates by 0.75% in 2024. Falling gasoline prices also boosted hopes that the worst of inflation is behind us. Contributing to the market’s enthusiasm was the VIX, or “fear gauge” trading at historic lows. VIX derivatives are used as portfolio hedges by traders, hedge fund managers, and investment bankers because, when below 12, they were dependable bear market indicators. Both the Dow and S&P 500 set all-time highs as the VIX recently fell to a 4-year low, although a handful of Magnificent 7 stocks contributed to more than half of the S&P gains last year. Bitcoin also doubled. Even gold set a new record in dollars at $2,140/oz, surpassing the previous record at $2,075/oz in August 2020 before pulling back. Markets don’t often repeat but they often rhyme. What happens when the Magnificent 7 are no longer magnificent?

Is the War on Inflation Won?

Almost everyone, including central bankers, expected a recession last year. The good news. That didn’t happen. The bad news, having misread inflation, policymakers are now misreading its causes. And while investors are celebrating the myth that the inflation battle was won, core cost of living jumped 4% or two times the Fed’s 2% target. America’s Q4 GDP growth was a scorching 3.3% above the Fed’s and most economists’ predictions. As a reminder, it was notable Canadian economist John Galbraith’s (author of The Great Crash 1929) wry observation, “the only function of economic forecasting is to make astrology respectable.” The labour market remains tight with an expected catch-up in wages to come. Output is strong. Food costs are at record highs. The economy is very much alive and the widely expected global recession is not in sight. Although there was a deceleration in inflation’s momentum, it is a false dawn.

The fiscal fantasy will be reinforced by Mr. Biden's supply-side spending, especially his efforts to green the economy in this election year, which will guarantee even higher inflation. The US economy has been sustained by a series of budget deficits totalling an astounding 7% of GDP, which is concerning because it is higher than Argentina, presently experiencing 200% hyperinflation with two-fifths of its population living in poverty. America is experiencing the symptoms of Argentina's sickness. Like Argentina, the Fed has adopted populist economics, funding its fiscal deficits by buying government debt with freshly created dollars. While the red ink mounts, the US national debt reached a record $34 trillion. This has become increasingly challenging as the quantum US debt to GDP has increased to 124% of GDP. Although first thought to be temporary, inflation has become entrenched as a result of persistently high input and service costs. The situation was exacerbated by the Federal Reserve's decision last year not to lock-in near zero interest rates when nearly one-third of US debt required refinancing. While the Fed's balance sheet contains almost 25% of US debt, the government maintains a chronic current account deficit that depletes foreign currency and forces the US Treasury to issue $2.1 trillion in debt, or 7% of GDP, to sustain America's debt addiction.

For most, the American dream remains elusive and a myth. And like Argentina there is a similar social dysfunction with a perfect storm of self-inflicted domestic issues and more assertive foes abroad which has exposed the American dream as a nightmare. One area pushing up prices is that politesse matters more in this age of wokeism, with the weaponization of everything from justice, politics, to the legislature, to the rule of law, and to government structure. The goal is no longer to improve economic conditions; instead, pandemic freebies, gerrymandering politiks, and the largest peacetime deficit in history will cause inflation to remain higher for longer.

Everyone complains about the symptoms, but not the cause. Renowned economist Milton Friedman contended that since money supply is the source of inflation, it is the money supply itself that matters most in terms of monetary variables, not the Fed's balance sheet. Ironically as central banks spent the past decade trying to resurrect inflation, they not only missed their targets by country miles but underestimated the impact of their policies. And, the oracles even failed to spot inflation’s pickup after the pandemic restrictions were lifted. In addition to this delay, new shadow players such as global commodity trillion-dollar giants, ETFs, and private equity hampered the Fed's monetary policies. Wall Street’s financial engineering of securitizing risk increased the potential for big losses such that Jerome Powell was compelled to acknowledge that, "at those times, forecasters have to think outside the models," due to the way that the capital markets have evolved. He and others continue to ignore the fact that inflation is the result of too much money chasing too few goods.

Hyperinflation Now?

Simply, the Fed was forced to print money to replace key funding by foreigners who had boycotted the world’s biggest borrower’s needs. Markets are not worried because the US has a printing press which allows them to borrow in their own currency to finance spending. However as rising rates pushed the financing needs higher, America’s options became more limited. What about curtailing subsidies or higher taxes or cuts in spending? With an upcoming election and a divided Congress, getting tough on growing entitlements or defense spending is unlikely. History shows that lax central bankers and reckless spending, financed by a combination of money printing and heavy borrowings, the end result was often hyperinflation. From March 2020 to March 2022, US broad money supply M2 increased 40%, the most of any two-year period since 1871. To date, M2 has declined a paltry 3% on a year-after-year basis, and yet markets are screaming “uncle.”

Therefore, despite the Christmas "everything rally," we think the fight against inflation has really just begun. There are two reasons to be concerned. First a year ago, demand inflation was influenced by rising energy prices, snarled supply chains and the Ukraine war. Then cost-push inflation followed, with wage demands, a consumer boom and rising shelter costs which pushed up prices. With the inflation genie out of the bottle, oil for example is set to recover lost gains with low strategic stockpiles, OPEC cutbacks and Houthi Red Sea shipping disruptions. Wage inflation has yet to reflect recent generous pay packages. Mortgage rates are over 7% as are healthcare costs. Services remain resilient. The reports of inflation’s death were greatly exaggerated.

American Exceptionalism

Not all is Mr. Biden’s fault. Undoubtedly, the environment has changed. Since the global financial crisis of 2007–2009, the Federal Reserve and other major central banks promoted emergency Keynesian stimulus as a remedy for the economy, which resulted in the slashing of interest rates to almost zero and the purchase of bonds and mortgages, as part of four rounds of quantitative easing. Subsequently, investors developed an addiction to free money. America then doubled down and piled more debt following the Obama spending spree and subsequently, Mr. Trump’s sweeping tax cuts. Since 2010, the Fed has purchased almost half of the issuances to make up for the lack of foreign purchasers. The consequential $10 trillion of free money not surprisingly inflated numerous asset bubbles including the stock market and real estate, allowing households which accounts for more than 70% of GDP to amass huge pandemic savings and “YOLO” spending sprees. No wonder inflation is a problem. America itself has become the biggest bubble in history. Like the wars, the fight against inflation is far from ended.

If Mr. Biden keeps spending, the Fed must keep printing. The other inconvenient truth is that by raising premature hopes that the inflation battle was won, Mr. Powell had only normalized rates from the ultra-loose fiscal policies of the past. Indeed, rather than expect several rate cuts this year, the likelihood is that they will move up again in a reversion to the long term mean which is much higher. Then expectations will meet reality. Yet the red ink keeps spreading. Mr. Biden wants to spend his way to re-election with mammoth government spending at 25% of GDP, in greening the economy or forgiving student loans or bankrolling wars or extending pandemic subsidies. Mr. Biden has a choice, guns or butter. He wants both.

The last president who tried both was Lyndon Johnson who financed the Vietnam War and his Great Society of tax cuts which resulted in the tripling of the monetary base, a drop in the dollar and the worst inflation in American history. That ultimately forced President Nixon to abandon the gold standard because foreign creditors were redeeming their dollars for gold, fearful of America’s huge debt load. Back then US debt to GDP was only 30% yet America was threatened with insolvency. Also back then, the Fed believing the inflation battle was won, relaxed prematurely until the OPEC oil embargo disrupted energy supplies, boosting inflation to double-digit levels in 1980. It took almost four years of Fed Chair Paul Volcker’s tough medicine pushing rates to 22% to break inflation’s back. Noteworthy despite the increase in rates, gold went from $32 an ounce to a peak of $875 an ounce in 1980 for a 2,634 percent gain. Since then the dollar has not been as good as gold.

Because of the need to print money to underwrite their government’s spending and deficits, central banks led by the Fed are on the back foot in battling inflation. History teaches us that the monetization of debt leads to inflation and then ultimately hyperinflation. America’s debt load is unsustainable. Hyperinflation exists today in Venezuela, Argentina, Lebanon, Turkey and Cuba whose currencies have collapsed because their central banks were forced to print unlimited currencies to finance spending. Under Trump I, the Fed too was compliant accommodating two tax cuts and two spending bills. All this suggests that inflation fighting is a long-term endeavour and more than just clogged supply chains. After all, hyperinflation of the US dollar is already happening. It is not so different this time, particularly when democracy faces two threats and Mr. Trump is only one of them.

Despite Powell’s attempts to downplay his role in stoking irrational exuberance, coincidentally in an election year, the economy is expected to run “hot” and worrying is that the lethal combination of rising inflation and financial instability, makes it difficult for the central bank to take away the punchbowl and raise rates without taking a wrecking ball to the economy. Balance sheet or QT shrinking is in the past. The reality is that policymakers only want to muddle on and perpetuate the boom without the bust, at least until after the election. The other reality is that Beijing, Moscow and Tehran recognize the dilemma. We don’t.

Poisonous, Polarizing, Politics

The larger issue fueling inflation is war. Wars cost money and today there is yet another war, between the people and their governments. The Arab Spring in Egypt, Myanmar, Brexit in the United Kingdom, the 1968 Spring Revolution in Czechoslovakia, and the 2018 "yellow jacket protests" in France are examples of the populist revolution. America is in the midst of a cultural war. For a while people thought they were in control of the cyclical development of immigration, sovereignty and government, but a global wave of discontent has targeted those in charge as the challenges of power and capital were found to be not cyclical but structural. Voters' perception that "everything is broken" is stoked by high inflation, tight household budgets, strict Covid regulations, and income inequality. As an example, a global immigration backlash has fueled support with a sharp U-turn to the right. America’s elite universities have become political flashpoints following the Hamas-Israeli war, whilst the extraordinary stress of the pandemic has hurt the dismal science. The wars between the populist and the political elite have become a global phenomenon with Orbán in Hungary, Milei in Argentina (MAGA, Make Argentina Great Again), the Dutch elections and likely, the reelection of Mr. Trump. This is problematic because this year, over half of the world's population will cast ballots, with the US most pivotal.

Although Bidenomics helped trigger the market boom, Mr. Biden succeeded in helping his opponent. More think Mr. Trump will do a better job. After two years of high inflation, Americans are struggling to pay their bills while told that inflation is under control as food and energy prices (excluded in the core index) keeps skyrocketing. According to trade publications, the cost of a cheeseburger is up 63%. Immigration too is overwhelming cites, adding to the homeless problem and grievance politics of the day. The Democrats too are as divided and dysfunctional as the Republicans. Many believe that politicians behave as the elite of the Versailles court and voters feel disenfranchised, distrustful and disillusioned with their institutions, politicians and laws. In the UK, the post office has come under fire. In Canada, the government’s use of the Emergencies Act was found unlawful. After striking down Roe v. Wade which further divided the population, that other branch of government, a politicized Supreme Court will decide if states can ban Mr. Trump from running again. Religion too is divisive, particularly with faith tested by LGBTQ+ policies. Today there doesn’t seem to be a “middle ground” with schisms between the right and left never wider. The American election will be a pivotal war.

In the Shadow of US-China Rivalry

De-globalization has seen the unwinding of the efficiency and security of supply chains. As a result, the stretched global trade and supply chains are snarled from global shipping disruptions in the Panama, Suez Canal as well as the Red Sea which opens up new fronts, heightening the risk of a wider Middle East war and another round of cost-push inflation. Everything is going up, but incomes. As Mr. Biden seeks a second term, his foreign policy is in disarray.

Washington and Beijing remain polar opposites. The Sino-US cold war between the geopolitical rivals helped reshape the world into multi-polar blocs, raising the possibility of a war directly between major powers. The mistrust flows both ways. Trade sanctions initiated under Trump were kept by Biden. After shipping cheap goods to the West, China has shifted investments towards technology, renewables and becoming dominant in the critical minerals necessary for the green transition. As well, China processes more than half of the world’s lithium, cobalt and graphite with two-thirds of the world’s EVs made in China. Overall investment has been lost by sides.

While the shocks of recent years have forced geopolitical change in the world order, there was much ink spilled over the “rapprochement” between China and the US. But following the November summit, Mr. Biden inexplicably called Mr. Xi a “dictator,” highlighting the depth of the distrust between the two nations. Despite a fresh thaw in relations, the Cold War continues.

As it steps up its rivalry with the US, decoupling on security issues makes sense, but is costly for both because China’s economy is so deeply interconnected, particularly for Canada now in self- inflicted exile. For the first time in decades, foreign investment has decreased in China due to worries about tighter regulations and demand-side concerns about the country's economic expansion. The third year of a property slowdown has coincided with a decline in exports. Yet, China will grow by 4%-5% this year, enviable among Western countries. While China dominates the clean tech space, the West's efforts to catch up are currently experiencing an EV bust. This year, Shenzhen-based BYD has surpassed Tesla in EV sales despite US penalties, posing a challenge for governments that must decide between promoting the use of EVs while safeguarding their own manufacturers. In 2022, China added more solar capacity than the entire world. Countries rely more on China's markets than on the US as their main trading partner. 90% of Apple's products are still produced in China. Despite facing severe sanctions, Huawei – the largest telecom company in the world – saw a 20% increase in revenue.

In truth though, a military conflict between the US and China is unlikely since, in contrast to Russia, China has a population of over a billion people, greater natural resources, and geographic independence. For instance, there is increasing convergence in the energy sector as China secures the oil it needs from the Middle East, Russia, and Iran, undermining the unipolar hegemony of the United States. Given the expanding relations between China and Saudi Arabia, one of America's closest allies, energy security is of utmost importance, and the Middle East alliance that holds the majority of the world's oil reserves is crucial for geopolitical significance, security, and economic development. At the recent BRICS+ conference in Beijing, Arab and Muslim leaders reinforced America’s growing isolation with Israel, by calling for a two-state solution and a ceasefire. In the same day, a cease-fire was declared, along with the freeing of civilian hostages.

Multi-Polar Disorders

That other tool of war, sanctions appear to have lost their bite. Russian oil revenues are higher than a year ago. China and Russia have effectively bypassed the SWIFT system and de-dollarization is on the rise. Petroyuans have replaced petrodollars. BRICS+ will use other currencies for trade, diminishing the impact of dollar sanctions. China meanwhile has become the largest creditor in the world while the world’s largest debtor is weakened by wars and polarizing domestic issues. In addition, BRICS (Brazil, Russia, India, China, and South Africa) alliance is settling trade in local currencies rather than US dollars. Furthermore, the unprecedented hoarding of gold by central banks may be explained by reports of a gold-backed currency trade settlement system involving the BRICS+ (Saudi Arabia, UAE, Egypt, Iran, and Ethiopia).

The US has become more isolated and less powerful during the past 20 years due to a number of factors including political dysfunction, a worldwide epidemic, a string of booms and busts, and wars. With the relative decline in western power and new world disorder, the lack of a policeman has ushered in a rising tide of aggression, from a spate of regime changes to military coups and outright annexation. In Africa there have been eight coups in the past three years. In Latin America, emboldened by Russia’s invasion of Ukraine, Venezuela threatened to annex two-thirds of Guyana (a commonwealth member) to access rich offshore oil reserves, based on an old border dispute in 1899. India’s Modi wants to annex Kashmir. Russia’s invasion of Ukraine a year ago paved the way for former Soviet satellites Azerbaijan to annex parts of Armenia, without penalty. And there is the Middle East tinderbox, which could get much worse and inflationary.

The concurrence of multiple crises and the lack of deterrence has made the unthinkable possible, helping drive up energy and food inflation. In contrast as Washington’s geopolitical clout wanes, it no longer has the tools to give it leverage with a shrinking military footprint not only in the Middle East but elsewhere. The bigger problem is that the market has become too complacent about the risk of contagion from these global conflicts. What then if Putin wins?

Trump and the Yes Men

With respect to that war, the United States is Ukraine's largest military backer having provided more than $110 billion of military and humanitarian aid to hold back the Russian army. That amount is unlikely to be increased much with Congress deadlocked on providing additional support. The EU too is struggling to reach a budget deal that would send $50 billion to Ukraine. Other nations have scaled back support, such as Germany stymied by a debt-brake court decision which froze public spending. Mr. Trump is unlikely to be a staunch supporter of these wars. Thus, the leader of the free world risks owning Ukraine’s failing war and spreading to western Europe would be a massive blow to American influence in the world. But the fragility of the Ukraine situation is overshadowed by the Hamas-Israeli war where the Biden administration is paying a heavy political price at home and abroad. For now, isolationism is paralyzing US policy. The US is not alone. To further contribute to geopolitical fragmentation, other nations are also acting unilaterally on issues ranging from war to climate change. All this feeds into American politics reinforcing a “fair weather” approach, alarming both friends and allies.

The countdown begins to the presidential election and this time, Mr. Trump is better organized, better financed and unlike the last time, from his cabinet down, everyone is a MAGA acolyte. Although in his first term he oversaw a non-inflationary boom, this is a pivotal time. There is another war, for the soul of America. Underpinning Mr. Trump’s strength is that more than half of the population is concerned about crime and immigration, not the greening of America, and thus this transactional president will owe no one for his victory. With fewer restraints on carrying out his political agenda, his protectionist instincts, moderated in the first term, will be unbound, allowing him to raise tariffs, build his wall or introduce more unfunded tax cuts. His election would only reinforce his theory of governance, weaponize the Constitution and his isolationist foreign policy could see the collapse of NATO and, the nuclear umbrella which could spark a brand-new nuclear arms race. And by using his new found presidential powers he could not only attack the legitimacy of the past election, but its institutional freedoms, undermining democracy itself. It is a slippery slope.

Yet Another War, Trade

There is a broader sense of déjà vu in motion. In the United States, despite near full employment, growing GDP, and progress on inflation, only 39% of voters approve of President Biden’s stewardship, according to Gallup polling. Alarmingly poll after poll shows Mr. Trump leading Biden in five of six key battleground states and a Trump 2.0 would not only pose a danger to democracy but tip the economy into fiscal insanity at a time of structural higher debts. Deficits must still be reined in, immigration solved, inflation mastered and wars to be fought. Add to that, the prospect of a 10% across the board tariff hike that would spark a new global trade war, reminiscent of the Great Depression of the 1930s which had its roots in dissatisfaction and protectionism.

It was then that President Hoover introduced the infamous Smoot-Hawley tariffs which drove up prices on thousands of imports and the “beggar-thy-neighbour” trade policies exacerbated the worst economic downturn in history as countries attempted to boost exports using tit-for-tat tariffs, competitive devaluations and import quotas. A sidebar was Homestake Mining which mined gold when gold was fixed at $32/oz was considered a proxy for gold in the Great Depression. As a store of value, Homestake, the original Magnificent 1, rose from $65 to over $480 per share, paying out $128 per share in dividends. Then in January 1934, the Fed suspended convertibility into gold and it became illegal to own gold. The government subsequently confiscated everyone’s gold and raised the price to $35/oz, effectively devaluing the dollar. Of note much of the 8,000 tonnes of gold held at Fort Knox today came from that confiscation as the dollar no longer became good as gold. The risk today is that our self-interested politicians, having exhausted the free money experiment will find it impossible not to succumb to the Trump 2.0 destructive instincts about power. The markets have become too complacent about the risk of a Trump second coming.

As Good As Gold

At center stage is the US dollar. For half of the century, the dollar has not stood for a sum of gold but instead was simply an arbitrary value backed by the good faith and credit of America. America’s fiat financial hegemony allowed it to print money in excess of revenues, wage wars, pay bills, and consume more than they produce. That structural weakness eroded the purchasing power of the dollar losing 99% of its purchasing power. The Fed can’t finance America forever. One day the US will face a financial crisis without sufficient wealth to issue money, pay its bills let alone debt. Already the world uses fewer dollars and with the formation of multi-polar blocs, America’s hegemonic status has declined at a time with the loss of confidence in its political system, economy, and institutions. Wars, sanctions, rating downgrades and the emergence of alternatives has tested the dollar’s “exorbitant” privilege, particularly since China and others fear that their reserves held in euros or dollars may no longer be safe amid the risk of confiscation. A nation must inspire confidence to keep this Ponzi scheme alive, but the Fed’s recent rate increases has already caused the failure of three banks and the upcoming onslaught of bond issuances will prove daunting without the support of America’s traditional buyers. The US dollar is vulnerable.

Therefore, a reliable currency is required in a world where many shared global concerns exist. We believe that gold is that physical reality, not dependent on any country’s accounting system, debt-ceiling discussions or dictates. Noteworthy with the US weaponizing the dollar, its share of global reserves has slipped to 59.2% in the third quarter, according to the International Monetary Fund (IMF) while the euro’s share in reserves increased to 19.6% and other claims in yen, gold etc. climbed. The biggest threat to the dollar’s haven status comes not from currency alternatives but itself. Will a second Trump presidency help?

America Will Elect an Inflationary President Again

“Today I'm here to tell you that the Western world is in danger. And it is in danger because those who are supposed to have to defend the values of the West are co-opted by a vision of the world that inexorably leads to socialism and thereby to poverty.” Donald Trump? No Javier Milei, President of Argentina.

There is a cost, a tipping point. Since the US is the biggest debtor in the world, the stability of the US financial system is dependent on the dollar's performance. Compare the balance sheet of the US government, companies and consumers since the early eighties. In 1980, government net debt was nil. Today it is $34 trillion, up $11 trillion in only 4 years. Similarly, the current account deficit that was balanced, today is 3.1 percent of GDP. At the same time, Bidenomics has produced the largest peacetime budget deficit in history at $2 trillion, double its long-term trend. This election year it will be worse. Meantime US household debt topped a record $17 trillion at more than 10 percent of disposable income.

Liquidity last year became a problem as central banks led by the Fed sold down their huge portfolios in the form of quantitative tightening (QT). But the tightening didn’t last a year and with trillion-dollar deficits as far as the eye can see, the Fed’s bloated balance sheet remains is only 7% from record highs but eight times higher than when Barrack Obama took office. In fact, the EU’s central bank’s balance sheet represents almost half of Europe's GDP, making it near impossible to reduce without severe negative consequences. Simply monetizing debt is the path of least resistance. Then there is that $1 trillion interest bill which is more than America spends on defense.

Due to a shortage of domestic savings, the US must import excess savings from other countries in order to finance its enormous current account and trade deficits. This highlights the necessity and vulnerability of America's reliance on foreign investors to close the fiscal hole. At more than 10 percent of GDP, the US twin deficits (budget and current) are more than twice the average for other countries, a precondition for hyperinflation. Deficits are out of control with growing leverage, damaging confidence in the US financial system. And there is no mechanism to reduce them. Debt on debt is not good. Too much debt is America’s Achilles’ heel. Add to that America’s isolation potentially made worse by a Trump 2.0 and the resulting trade hostilities could usher in a cycle of competitive devaluations, reminiscent of the 1930s. Mr. Trump added some $9 trillion to the national debt in his first term. Will a Trump second term bring down the deficit?

Money is Money

Money is money. Or is it? The basis for money is a medium of exchange, which is both liquid and convertible in which a large number of people believe that it will retain value. For a time, bitcoin was considered a new alternative as a medium of exchange, but it is not a store of value. However for thousands of years, gold fulfilled this role as a currency from the pharaoh’s time to King Ferdinand of Spain in early 1500’s, and even lately in the seventies as a hedge against inflation when amid the wreckage of the Bretton Woods system and America’s crushing indebtedness, President Nixon was forced to remove the dollar’s convertibility into gold, effectively devaluing the dollar.

Since then an alternate investment option for central banks is gold. Prior to retesting at $2,000/oz, gold saw a 13 percent increase last year and reached a record high of $2,135/oz. Gold is money. The value of gold is not conferred by governments, its supply is limited and unlike fiat dollars gold cannot be created with a click to effect desired economic outcomes. Central banks have been hoarding gold at a record pace lately, with some hoping to match Germany, France, and Italy's reserves of 4% of GDP. The World Gold Council claims that a gold rush by central banks resulted in them purchasing a record 1,136 tonnes in 2022 and 1,137 tonnes in the first nine months of last year, setting a new record and carrying over a decade of significant buying. The BRICS too were also big buyers as some sought to avoid Russia-style sanctions as well as diversify their holdings to avoid further dollar debasement. Poland purchased 300 tonnes bringing holdings to 3% of GDP. Bank of Mongolia bought 16 tonnes. Ironically, with no gold in its reserves, gold-producing Canada was conspicuously absent. On the other hand, China’s holdings are believed to be about 2% of GDP. China has purchased gold every month for the past 12 months possibly because they know the dollar is not as good as gold heeding the advice of former Fed Chair Greenspan who once said, “gold still represents the ultimate form of payment in the world as gold is always accepted.”

Domestic demand was strong in China and India who were among the largest buyers for jewelry consumption. China was the largest producer in the world at 375.16 tonnes last year and its Shanghai Gold Exchange (SGE) is the largest physical gold exchange, helping China boost its reserves to 2,226 tonnes. China has the fifth largest stockpile behind the US which has 8,133 tonnes but is less than 4% of its foreign exchange of its reserves in gold. On a retail level, in November last year the SPDR Gold Share ETF saw net inflows of more than $1 billion, reversing months of outflows. And, one of the world’s largest retailers Costco sold $100 million 1g wafers at a premium reflecting, “if you sell it, they will come.” Simply, there is more demand than supplies. Consequently, we have revised upward our $2,200/oz target to $2,500/oz.

Recommendations

Gold stocks however have underperformed. We believe one of the catalysts that will help gold shares’ performance is reserve replacement. Gold miners are running down their reserves and have not replaced their production. Moreover, we calculate the industry market cap per reserves at a historic low of $500/oz and thus it is cheaper for miners to acquire ounces on Bay Street than to fund exploration and wait up to 10 years to exploit a discovery. Gold mines are now value stocks. A decade old bear market has resulted in capital and operating discipline such that they are generating huge cash flows with AISC at $1,200/oz. Investors have yet to capitalize but the gold miners themselves have acquired each other in a game of musical chairs. As such we expect continued M&A activity, particularly since most of the majors have cash and are looking to expand. However, the game of musical chairs is long in the tooth and there are fewer chairs available. Barrick and Agnico instead are acquiring small stakes in juniors, and we see the mid-tier group of stocks disappearing either through mergers or they will be taken out. Eldorado bought a strategic piece of Amex Exploration.

We like the senior producers Agnico Eagle, Barrick and B2Gold. We also like developers/producers such as Endeavour, Eldorado, Lundin Gold and McEwen Mining.

Agnico Eagle Mines Ltd. (AEM) – Canada’s largest miner, Agnico Eagle reported production in line with expectations with contributions from Canadian Malartic, Detour and Fosterville. The quarter was impacted by a planned shutdown at LaRonde which was offset by a strong quarter from Amaruq. Agnico has a strong pipeline of brownfield projects, particularly in the large Kirkland Lake gold camp. Agnico Eagle should produce 3.3 million ounces from its 11 mines this year and we view the shares a strong buy.

Barrick Gold Corp. (ABX) – Barrick Gold, the second largest miner in the world, has the largest array of Tier 1 assets. The miner produced 1.04 million ounces of gold and is on track to produce about 4.1 million ounces this year with contributions from the Nevada Gold Mines (NVX), Pueblo Viejo in the Dominican Republic and the reopening of long life Porgera in Papua New Guinea (PNG). Copper output at 420 million pounds was at the lower end of expectations and represents about 20% of Barrick’s value. Costs were as expected from Barrick’s major mines in Nevada, Africa and South America. Rumors of Barrick boosting its copper output by acquiring problem prone First Quantum whose flagship Panama was shutdown, were denied by Barrick's Bristow. Although Barrick will have a flat year, we like Barrick for its copper project pipeline including the huge $5 billion Reko Diq in Pakistan and Super Pit Lumwana which has a 30-year life that would increase Barrick’s exposure closer to 25% of valuation. We like Barrick’s long-term assets here for its long life and reserve position.

B2Gold Corp. (BTO) – B2Gold results from its three operating gold mines Fekola, Masbate and Otjikoto were in line with expectations. Production was flat this year as mining at high grade Fekola in Mali was stalled due to permit issues. Gramalote is being revised as a smaller scale operation. B2Gold’s cash flow has been directed to the buildout of the Back River project in Nunavut and that mine will be a major contributor next year. Construction is well ahead at Back River with remaining capex at $890 million. Back River hosts a resource of 9 million ounces (3.6 million ounces 2P reserves) and is a long life mine and company builder. Initially planned as an open pit at Echo and underground (Umwelt), Back River has a huge property position so there is upside exploration potential. Back River is expected to produce 300,000 ounces annually for the first five years of production. We like B2Gold for its low mining cost profile and rising production profile.

Centamin PLC (CEE) – Centamin had positive results producing 450,000 ounces from the Sukari Mine in Egypt which is a slight increase over last year. In the fourth quarter, Centamin produced 129,000 ounces and expects to produce 475,000 ounces at AISC of $1,300/oz this year. Unlike others, Centamin boosted reserves by 10% to 5.8 million ounces. Centamin is the largest producer in Egypt and benefited from recently built 30 MW solar facility which reduced costs. Also, the company has increased reserves and begun drilling at its large Eastern Desert land position where its EDX concession represents some 3000 km2 of land. The company’s drill plan targets 285,000 metrics this year. Sukari Gold Mine’s new life of mine (LOM) plan will extend its life, with expectations of producing 500,000 ounces a year at AISC under $1,000/oz for the next nine years. A new Egyptian mining and fiscal regime is also helpful. We like the shares here.

Centerra Gold Inc. (CG) – Centerra released a strategic plan for its two mines at Öksüt in Turkey and Mt. Milligan copper/gold in BC. Öksüt is expected to run through 2029. Mt. Milligan’s moly restart is in the planning stage, but IRR makes a restart unlikely. Centerra has never replaced its flagship Kumtor Kyrgyz Republic mine which was nationalized on unfavorable terms. Goldfields is still an early exploration bet. Centerra has a strong balance sheet, but we prefer others here.

Eldorado Gold Corp. (ELD) – Eldorado had terrific results with a strong quarter from leaching operation Kışladağ in Turkey. Efemçukuru also in Turkey has another five-year life. Eldorado’s Lamaque mine in Quebec had a record quarter. We like Eldorado here as Skouries build-out in Greece is being completed as a long- life gold/copper project. Production is expected next year for a total capex at $850 million. Eldorado did not replace reserves which declined by 5% last year, due to depletion. Mid-tier Eldorado has a strong enough balance sheet to build-out Skouries which is a company builder. Next year, Eldorado should be piling up the cash. We like the shares here.

Endeavour Mining Corp. (EDV) – The gold producer shocked the street by firing its CEO Sébastien de Montessus for alleged “serious misconduct” over costs granted to an unarmed security company. Seasoned Ian Cockerill replaced Sébastien, and the company released strong results producing 1.1 million ounces at AISC $964/oz. Major contributors were Sabodala and Endeavour is expected to produce 1.2 million ounces this year. However, Hounde gold miners in Burkina Faso went on strike. We like the shares, particularly on this weakness.

IAMGOLD Corp. (IMG) – IAMGOLD is a mid-tier producer developing the $3 billion Côté Lake gold project in northern Ontario which is almost complete. First production is expected in the current quarter and the processing plant commissioned later on this year. Essakane produced 108,000 ounces due to better grades, but security at Burkina Faso is uncertain making Essakane geographically risky with costs at Essakane under pressure due to local fuel disruptions. Westwood had a decent quarter producing 28,000 ounces up from 18,000 ounces last year. IAMGOLD’s balance sheet is being strained by the over-budget and delayed Côté build-out and we expect teething problems and shortfalls made worse by the 150,000 ounce forward gold sale at lower prices. Sell.

Kinross Gold Corp. (K) – Kinross had results in line with expectations and is on track to produce 2.1 million ounces this year. The company continues to expand open-pit Tasiast in Mauritania as it goes underground in the next decade. A new mine plan at Round Mountain Phase S provided some life to the maturing mine. Kinross continues to develop Great Bear which is a long way off from production and thus little is reflected in our NAV as they drill off the deposit – so much money, so little results. Round Mountain and Great Bear will be part of $1 billion plus capex this year. Kinross has mature mines, so growth is a problem. We prefer Lundin Gold to Kinross.

Lundin Gold Inc. (LUG) – Lundin Gold had terrific results producing 480,000 ounces at Fruta del Norte (FDN) in Ecuador this year. Guidance is for a slight improvement as the world's richest gold deposit continues to produce efficiently. The miner paid down debt and AISC was under $700 an ounce as it hopes to increase throughput to improve recoveries by spending $36 million on a plant expansion. The company is also spending $42 million on an extensive regional drilling program in effort to look for another Fruta del Norte. Lundin should produce 475,000 ounces this year at AISC under $900/oz. Next year, the miner’s guidance is 500,000 ounces at AISC of $800/oz. A resource update is expected shortly. We like the shares here.

McEwen Mining Inc. (MUX) – McEwen had a decent quarter as they continue to develop the Fox Complex where mill rate increased with output in the last quarter near 46,000 ounces. At Gold Bar a new leach pad was built and were mining a lower strip ratio. Results year over year have improved and the company's large Los Azules project in Argentina undergoes development (14 rigs turning). The sale of Los Azules interests to Stellantis and Rio Tinto enabled McEwen to boost its balance sheet and work on bringing the project to feasibility. We like McEwen here for its holding in Los Azules which is valued at half billion dollars and thus a McEwen shareholder gets McEwen’s three gold mines for free. Production is estimated at 150,000 ounces (GEQ) at Fox, Gold Bar and San Jose. We like the shares here.

New Gold Inc. (NGD) – New Gold had a flat quarter with the contributions from New Afton in BC and Rainy River in line with expectations. New Afton grades were better as the mine is in transition. New Gold should produce 265,000 ounces this year with an improvement at Rainy River in Ontario. Costs remain high relative to its peers. New Gold’s balance sheet is weak and refinancing of OTPP is expected. We prefer MUX here.

Newmont Corp. (NGT) – The world’s largest gold player, Newmont had a sloppy quarter as it integrates Australian Newcrest and an updated resource is expected following the acquisition of Newcrest Production at Peñasquito in Mexico was better now that the workers are back but stripping will impact this year’s output. We prefer Barrick here because Newmont is expected to spend management time and money integrating Newcrest, similar to the problems of integrating the Goldcorp acquisition. Newmont is set to spend $1.2 billion, partly on Pamour to extend its life. Meantime, lower output from Newmont’s Ahafo in Ghana and Boddington in Australia will hurt this year’s results. Size does matter here, problems not ounces. We prefer Barrick.

Editor’s Note: Commentary and opinions expressed in this Special Report are those of John Ing, President and CEO, Maison Placements Inc., an independent investment banking firm headquartered in Toronto, Canada. Founded in 1955, Maison’s success has been built on providing unique advisory services. As a leading independent investment bank the firm has arranged private placements, equity underwritings, rights issues and advised on asset purchases. The firm provides independent advice, with an emphasis on long-term relationships and finding innovative solutions. For more information on Maison Placements Canada, visit www.maisonplacements.com.

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