• Gold

    The Superlative Impact of Supermajors

    Joe Foster,
    08 February 2019
     

    Gold breaches $1,300 level amid Fed moves

    On 25 January, gold moved above the psychologically important US$1,300 per ounce level on anticipation of an earlier-than-expected end to the Federal Reserve’s (Fed’s) bond portfolio sales. The Fed’s comments suggested that the US central bank is, indeed, in “pause” mode, and that future market and economic conditions will determine whether it would revert back to easier crisis-era policies. As a result, gold advanced to a nine-month high to end January with a US$38.76 (3.0%) gain at US$1,321.21 per ounce. Gold stocks also gained, with the NYSE Arca Gold Miners Index advancing 7.5% and the MVIS Global Junior Gold Miners Index up 9.5%. Mining news was dominated by the Newmont Mining and Goldcorp merger.

    Signs of softening growth emerge globally

    While the Fed is clearly concerned about the health of the US economy, reports released elsewhere in January also showed mounting concerns over a global economic slowdown. China’s Caixin manufacturing survey experienced its second consecutive month of contraction and the lowest reading since 2016, German industrial production fell 4.7% year-on-year, while France’s annual GDP growth slowed to 1.5%. The OECD’s Composite Leading Indicator suggests that 2019 global growth is losing momentum. On 28 January, the ECB indicated that it is ready to use all its policy tools to support Europe’s softening economy.

    Central bank purchasing of gold picked up in 2018

    While the US dollar index fell slightly in January, it has not relinquished its 2018 gains due to the growing economic weakness outside the US. Accordingly, the gold price advanced across most local currencies and the US dollar. This is historically safe haven behaviour when investors sense increasing financial risks globally.

     

    The World Gold Council reported that central banks purchased 651 tonnes of gold in 2018, the second highest total on record. Central banks have been net purchasers of gold since 2010 as more countries are finding a need to diversify their paper currency reserves. While China was a consistent buyer earlier in the decade, it has not reported any purchases for nearly two years. But in December, Beijing reported an increase in gold reserves of approximately 10 tonnes. It remains to be seen if this signifies a resumption of regular Chinese buying.

    Gold eyes $1,365 price ceiling in 2019

    Central banks are running out of time to normalise policies amid preparations to stimulate economies through the next recession. The Fed funds rate appears to have peaked at just over 2% while the balance sheet seems to be bottoming at US$4 trillion. Meanwhile, the ECB can’t get its policy rate above negative 0.4% after purchasing US$3 trillion worth of bonds. What will the financial system look like when the Fed funds rate falls to zero (or less), fiscal deficits exceed US$2 trillion annually, and the Fed bond hoard tops US$10 trillion? We may find out in 2020.

     

    The recent shift in Fed policy was the catalyst that moved gold through its first significant price hurdle of US$1,300 per ounce. It seems likely that gold could now test the more formidable US$1,365 level, which has acted as a price ceiling for the past five years. If further fundamental risks develop around Brexit, the economy, or the stock market, then gold and gold stocks may finally move into a higher price range.

    Newmont-Goldcorp joins supermajor class amid focus on profitability

    The structure of the gold industry has changed with the announcement of a second blockbuster merger in January. The first was the Barrick-Randgold combination announced last September. Not to be outdone by Barrick, Newmont announced plans to acquire its peer Goldcorp in an all-stock deal valued at US$10 billion to create the world’s largest gold company. Like Barrick, Newmont intends to sell non-core mines to focus on a smaller portfolio of larger, higher quality properties. However, the enlarged Newmont will have 21 mines (Barrick has 13), so integrating both companies will be a challenge.

     

    Goldcorp’s current management was a disappointment. Since taking charge of the company three years ago, they have missed earnings expectations half of the time.  As a result, Newmont is acquiring an excellent suite of assets at a discount and Goldcorp shareholders will get the quality management they have long been waiting for.

     

    There are several implications this transaction will have on the industry that we find interesting:

    • These mergers create an exclusive class of majors that no other company or combination of companies will be able to replicate. Supermajors Barrick and Newmont will produce between five million and eight million ounces per year. Majors Anglogold, Kinross, Goldfields, Newcrest, and Agnico Eagle have production targets ranging between two million and four million ounces per year. The supermajors will have unmatched economies of scale and the liquidity to attract the largest institutional investors.
    • Today’s companies have a streamlined management structure, proper incentives, and the experience of past mistakes to drive value creation. Nonetheless, execution will be challenging for these two behemoths.
    • In the gold industry, bigger isn’t necessarily better. History has shown that acquisitions often don’t pay off, and having too many mines becomes difficult for a single company to manage. A number of mid-tier CEOs have commented that six to eight mines are optimal.
    • Past cycles saw majors merge to get bigger. This cycle they are merging to become more profitable. The managements of Newmont and Randgold believe they can instill proven management structure, efficiencies, and technology in their new companies. They are also looking to divest unprofitable mines. If successful, they will be smaller (though still supermajors), more profitable companies in a couple of years.
    • There are roughly ten mines between the two supermajors with values ranging between US$100 million and US$1 billion that are now up for sale. The potential buyers are the majors and mid-tiers. We know many examples of aging mines that were neglected or undercapitalised, but later became successful core properties after being sold to a smaller company. We hope to see more win-win transactions that bring a source of growth and value creation to the majors and mid-tiers.

    Through the low gold prices of the past six years, we have seen financial, operating, and capital discipline that we believe is here to stay. Corporate structures are flatter and more responsive. We expect the supermajors to create value and set new standards for the industry.

     

    All returns are in US dollars

    IMPORTANT NOTICE: Issued by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 (‘VanEck’). VanEck is a wholly owned subsidiary of Van Eck Associates Corporation based in New York, United States. VanEck Vectors ETF Trust ARBN 604 339 808 (the ‘Trust’) is the issuer of shares in the VanEck Vectors Gold Minders index ETF (‘US Fund’). The Trust and the US Fund are regulated by US laws which differ from Australian laws. Trading in the US Fund’s shares on ASX will be settled by CHESS Depositary Interests (‘CDIs’) which are also issued by the Trust. The Trust is organised in the State of Delaware, US. Liability of investors is limited. VanEck Associates serves as the investment adviser to the US Fund. VanEck, on behalf of the Trust, is the authorised intermediary for the offering of CDIs over the US Fund’s shares and issuer in respect of the CDIs and corresponding Fund’s shares traded on ASX.

    This information contains general advice only about financial products and is not personal advice. It does not take into account any person’s individual objectives, financial situation or needs. Investing in international markets has specific risks that are in addition to the typical risks associated with investing in the Australian market. These include currency/foreign exchange fluctuations, ASX trading time differences and changes in foreign laws and tax regulations.  Before making an investment decision in relation to a fund, you should read the PDS and with the assistance of a financial adviser consider if it is appropriate for your circumstances. The PDS is available at www.vaneck.com.au or by calling 1300 68 38 37.

    Past performance is not a reliable indicator of future performance. No member of the VanEck group of companies or the Trust gives any guarantee or assurance as to the repayment of capital, the payment of income, the performance or any particular rate of return from the US Fund.

    An investment in the US Fund may be subject to risks that include, among others, competitive pressures, dependency on the price of gold and silver bullion that may fluctuate substantially over short periods of time, periods of outperformance and underperformance of traditional investments such as bonds and stocks, and natural disasters, all of which may adversely affect the US Fund. Foreign investments are subject to risks, which include changes in economic and political conditions, foreign currency fluctuations, changes in foreign regulations, and changes in currency exchange rates that may negatively impact the US Fund’s return. Small- and medium- capitalisation companies may be subject to elevated risks. The US Fund’s assets may be concentrated in a particular sector and may be subject to more risk than investments in a diverse group of sectors.

     

    NYSE Arca Gold Miners Index is a trademark of ICE Data Indices, LLC or its affiliates (“ICE Data”) and has been licensed for use by VanEck in connection with the US Fund.  Neither the Trust nor the Fund is sponsored, endorsed, sold or promoted by ICE Data.  ICE Data makes no representations or warranties regarding the Trust or the Fund or the ability of the NYSE Arca Gold Miners Index to track general stock market performance.

    ICE DATA MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND HEREBY EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE WITH RESPECT TO THE NYSE ARCA GOLD MINERS INDEX OR ANY DATA INCLUDED THEREIN.  IN NO EVENT SHALL ICE DATA HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.

     

    Please note that the information herein represents the opinion of the author, but not necessarily those of VanEck, and this opinion may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.