Financial Risks Position Gold for Bullish Turn
ROLAND MORRIS: Welcome. I'm Roland Morris, the Commodity Strategist for VanEck. I'm joined today by Joe Foster, the portfolio manager of our active gold miners’ fund. We're going to discuss gold, and gold miners today. Joe, welcome and thank you for joining us.
Gold really last declined sharply in 2012 and ‘13, and really ever since then, almost five years now, we've been in a trading range, which is really from $1,100 to $1,400 per ounce, but mostly between $1,200 and $1,400. What do you think of the current situation in the gold market, as far as the outlook for the commodity, where we've been and where we might be headed?
JOE FOSTER: You're right. We've formed, I guess, a massive base in the gold sector. Maybe in the history of markets. I don't know if we've seen such a base-build for the last five years. You know, gold and gold stocks went through a bear market that started in 2011, and it ended in 2015. A lot of selling occurred in that bear market. And because of that, I don't think there's a lot of selling pressure on the metal as a result of that. All the weak hands have been cleared from the market.
As a result, there hasn't been a lot of downside pressure on gold. So, it has resulted in this long base. At the same time, we haven't had a strong catalyst on the upside. Gold responds to financial risk, especially, geopolitical risk, and other types of risk that affect the global financial system. We haven't had a strong catalyst to get gold out of that range over the last several years.
MORRIS: Interesting. When you think about it. I am a fan of charts and this is some base we've built. Can you think right now if some of the current geopolitical events in the world, and something that in your mind might trigger a resumption of a new bull market for gold out of this space, and off this space?
FOSTER: I think what we're seeing is, I call it, an economic death by 1,000 cuts. All these things that are making headlines, whether it's a currency crisis in Turkey, or the trade wars, or looking back to the North Korean situation, these create risks, but they're more local in nature. But I think eventually, we're seeing these risks increase in frequency, and starting to build.
And I think it's going to reach, maybe, sort of a critical mass, where investors start saying all these risks all over the world are going to amount to something bigger and more global and more systemic. And I think that's what ... When we might see the gold market turn, as investors start to hedge themselves against these accumulating risks all over the world.
MORRIS: Interesting. When I think of gold, I think of sort of two potential events. One would be a strong inflationary environment that can generate interest in gold, but also, as you said, hedge against financial risk. Do you think there is a chance that inflation, after really what has been a historic monetary policy stance globally for the last five, well, eight years really, do you think there is a possibility of inflation being triggered? Or do you think it's more likely to be this financial contagion that leads to the move?
FOSTER: I think the risk of inflation now is higher than it has been in many years, because of the tight labor markets, the trade situation that we're seeing. We are seeing some price pressures. The trend of inflation over the last 12 months has definitely been on the upside. But in the longer term, the other thing you have to consider here is the Fed [U.S. Federal Reserve] is raising rates now. The Fed is tightening. So, they're withdrawing the liquidity that drove the expansion and that drove the booming stock market that we've had over the last 10 years. So, I think because of that Fed tightening, it sort of counterbalances the inflationary pressure.
So, I think, sure, there's risk of inflation. There is also risk of financial stress, and the risk that this expansion could come to an end as the Fed raise rates, as it has every time, just about every time, the Fed has raised rates in the past. So, there are two competing factors there.
MORRIS: So, if I'm hearing you correctly, it sounds like you think really a financial calamity of some sort is more likely than inflation building.
FOSTER: I do.
FOSTER: Again, coming to the end of this economic cycle, there's many indicators that suggest that we're closer to the end. In baseball terms, we're in the eighth or ninth inning of this cycle. Yes.
MORRIS: And of course, as a lot of financial press has noticed, really the accumulated debt has just gone to a new level in this cycle.
MORRIS: We somehow doubled down on the idea of running expansions with debt, really.
FOSTER: If the cycle does come to an end, that's the biggest risk. I think in the next downturn, we're not going to be talking about subprime mortgages, we're going to be talking about sovereign debt, corporate debt…
FOSTER: …junk bonds, things of that nature that have reached historic proportions in this cycle.
MORRIS: Relative to growth?
FOSTER: Right, yes.
MORRIS: That's interesting. Well, now let's move on to the companies. I've heard you say a number of times that you think the industry is in great shape, they've contained their cost. The companies are in great shape. Can you tell us a little bit more about your view of the companies' position right now financially?
FOSTER: They're in great shape. A lot of companies took on way too much debt in the good years when the gold price was rising. They paid for it in the down years, but they've managed to get cost down, generate cashflow, sell assets, and pay down their debt. So, their balance sheets are in good shape now. Financially, they're strong. Operationally, they're strong as well. Again, like I said, they've got their cost down. They've found much better financial discipline to where they're building projects with good double-digit rates of return. So, generating returns for shareholders that we haven't seen in some time in this industry. So, fundamentally, yes.
MORRIS: That's great. So, it seems to me that you would make the argument, and I know we as a firm make the argument that, at this point, if you're going to have gold exposure, it would make more sense to actually own the companies than the commodity.
FOSTER: Yes. And the other key factor here is that valuations are very low. So, the industry is healthy. In addition, valuations are at historic lows right now. So, these stocks are cheap. So if we do get some gold breaks out of this trend it has been in for so long, I think these stocks can show some very good performance.
MORRIS: Well, that's very exciting. And I, again, I am a fan of gold as a defensive holding for investors. Because there isn't really a good hedge. And it sounds to me like if you are worried about financial conditions, or if financial conditions start to tighten, gold mining exposure is a great way to have some hedges in your portfolio.
FOSTER: We're at the point in the cycle I think investors should think of some defensive measures. And gold should be part of that mix, for sure.
MORRIS: One other thing I wanted to talk to you about today, is that there's been some recent merger activity, and I remember hearing that you’d actually looked at the recent developments as pretty positive overall, for the industry, and could be another positive catalyst for gold miners. At least maybe start to drive their valuations higher.
FOSTER: It goes back to the theme that these gold miners have reworked the way they run their business. The announced merger between Randgold1and Barrick2, is an example of that. It's a deal done as a merger of equals. There are no premiums involved. Historically, we've never seen a deal of this magnitude done without a premium. Usually when a premium is announced, you have speculators coming in and shorting the stocks, and entering the market, and distorting the fundamentals of the market.
That can't happen in a merger of equal, like we've seen here. And as a result, instead of the acquirer’s stock going down the day the merger was announced, Barrick and Randgold both advanced after the merger was announced. And we've seen that both stocks advanced since then. So, I hope this is a development that we see more of: keeping the speculators out of these M& A deals and allowing these deals to stand on their own fundamentals.
MORRIS: Interesting. So, the combination of the two companies is really going to work for investors. And so, you're pleased with the way it was structured.
FOSTER: Yes. I think this brings in Randgold's management, which will now be joining Barrick, and it will get a more dynamic, entrepreneurial management, managing the largest gold company in the world. And we'll see what that brings us.
MORRIS: That sounds great. I'm very excited about the outlook. And it's great to hear your thoughts on it today. Joe, thank you very much.
FOSTER: Sure. Thank you.
MORRIS: Thank you very much for joining us today for our discussion on gold and gold miners. For more information, please visit our website vaneck.com.
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1Rangold Resources Limited was 2.6% of the VanEck International Investors Gold Fund as of September 30, 2018
2Barrick Gold Corporation was 3.5% of the VanEck International Investors Gold Fund as of September 30, 2018
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