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Gold: It Is What It Is

If there ever was a year when the unforeseeable can happen, this is the year. Covid-19 plunged economies into a recession, but the turbulent markets reached all-time record highs as interest rates collapsed to near zero levels as part of the extraordinary moves by central banks to rescue their economies. Gold also reached an all time high of $2,064 an ounce, up from $1,700 in May, in the expectation that the flood of trillions of newly minted dollars of stimulus, on a scale never seen before would ignite long dormant inflation. And US money supply surged to double digit levels as the US debases its currency seeking a competitive edge for its exports. Worrisome too, with everything in the US becoming politicized, is that the deeply divisive presidential election might not be settled in November due to constitutional challenges or a disputed election result, which could derail the dollar and market for the ensuing weeks or months.

Against the backdrop of polarising disinformation, there is a national crisis over trust and democracy itself as the US political divide widens from voting rights to racial injustice to police brutality. Armed civilians have become fixtures at marches for racial equality and the taking up of arms to enforce political will is a disturbing escalation of the peace marches and a sign of the deterioration of democracy’s fabric. And still the pandemic rages as the most powerful economy in the world slides into the worst slump since the Great Depression.

Gold Is a Barometer of Investor Anxiety

History shows that gold is money, it is under-owned. Its allure as a store of value is that it can’t be printed into existence. Unlike fiat currencies, gold is finite and the only way to increase the gold supply is to dig up more and it is this scarcity that is its attractiveness and the reason that gold is held in central banks’ reserves. Central banks know it is an asset, not represented by another’s debt or liquidity. The Bank for International Settlements (BIS), the bankers’ bank recognizes gold as a monetary asset with gold part of its monetary unit of exchange.

Central banks for the last decade have become the world’s largest buyers of gold and the US is the largest holder of the precious metal at 8,133 tonnes accounting for 78% of its reserves. China is the world’s largest consumer and producer of gold but their output is declining because of a crackdown in illegal mining. In addition, many of China’s mines have short reserve lives because their open pits are running out of reserves as the pits get deeper. In the meantime, Russia liquidated its entire US Treasury holdings, purchasing gold such that Russia’s gold holdings today is valued at $100 billion. We believe China has followed as a part of a strategic effort to hedge risk to the dollar.

China’s Golden Appetite

Russia has accumulated 2,192 tonnes of gold, followed by China at 1,936 tonnes, the sixth largest holder. Other major central banks too have added to their reserves purchasing almost 400 tonnes in the first half of the year. Although Russia has almost 20% of their foreign exchange reserves in gold, China has less than 3% and thus we believe China’s strategy is to increase their gold holdings. As the world looks for alternatives to the dollar as a reserve currency, however, there is not enough gold to satisfy China’s demands. We believe more likely is a renminbi currency basket tied to gold, which would replace China’s usage of the dollar.

Investors too have jumped on the bandwagon by joining the central banks in buying gold. In the Chinese investment world, retail buying has taken off with two new gold funds listed in China, collectively adding 3 tonnes of buying. Over the last eight months, global gold ETFs increased by 38% making up almost 35% of global demand. Year to date, gold ETF net inflows was almost 1,000 tonnes and gold ETFs now hold 3,824 tonnes making the ETFs the second largest holders in the world, after the United States and ahead of Germany. Also, following on the heels of legendary investor Warren Buffett’s Berkshire Hathaway purchase of $500 million of Barrick recently, the $16 billion Ohio Police and Fire Pension Fund invest up to 5% into gold as a portfolio hedge. Still, gold is underowned.

The Shanghai Exchange (SGE) has become the world’s largest physical gold trader and has even purchased storage vaults becoming one of the world’s major vault holders. With other countries holding the bulk of their foreign exchange reserves in gold, we believe China is desirous of significantly increasing their holding. The trouble is that there is not enough gold to satisfy China’s ambitions, either internally or externally. Therefore China has to buy reserves in the ground and thus we believe Western gold miners are the likely next targets. After all, the world’s second largest economy has the largest foreign exchange reserves in the world at $3.1 trillion, of which one third is held in US debt. America has become the biggest debtor in the world, so China’s superior financing power could dictate terms because America’s debt and deficits keep climbing in the misguided belief that they can “grow” their way out of debt.

Recommendation

America’s 2020 election in our view is one of the stock market’s biggest risks. Equally worrying is a potential Supreme Court fight which intensifies the partisanship on Capitol Hill that would be catastrophic as investors find themselves in the midst of an election result to be decided by a Court that is equally divided. President Trump has already called the election “rigged” and “one of the great embarrassments”, while state and local officials admit it might take a while to certify the election results and there is the post office which can deliver mail “rain or shine”, but might not deliver the ballots in this election on time.

Gold usually rises in times of fiscal uncertainty and, many times is a barometer of investor anxiety. We believe the uncertain election outcome and potential for a protracted result will introduce an unusual amount of market volatility and anxiety. We believe gold will continue to outperform stock markets as it has this year. The financial markets are going to be in serious difficulties. Gold is a defense against the unknown.

While we have long maintained a $2,200 an ounce target for years, we do not believe that this is the top. After reaching a closing high of $2,064 an ounce, gold corrected to $1,850 challenged by a recovery of the US dollar. A pullback and the ensuing need for a consolidation is not surprising since gold was at $1,700 in May. We believe that the pullback is a buying opportunity, with limited downside risk at $1,725 an ounce.

How high? How low the US dollar. A lower dollar would boost inflation and since the Fed will not defend the dollar by raising rates (under Powell’s new policy), the dollar could soon be in freefall. We also believe Mr. Trump’s retreat from the global stage in the face of rising global disorder is a repudiation of all things that made America great. We believe no matter the election outcome in the United States, major changes are ahead. Gold is a hedge against this uncertainty.

Since gold was $32 an ounce, we have observed that the barbaric metal always makes successive record highs. Since the coronavirus hit, gold has outperformed all assets. It is not so different this time.

In the latest quarter, M&A activity was quiet despite miners generating billions of free cash flow. Reserve replacement remains the key problem for the industry and it is cheaper to buy ounces on Bay Street than spending money with the drill bit. Consequently we continue to expect heightened levels of M&A over the next year or two. Further, there are a host of development prospects needing financing and most likely to find the capital needed in the current gold cycle. Canadian producers particularly benefited from the surge in gold as they received more than $2,700 per ounce for their production.

We believe M&A activity will be driven by the need for reserves, unlike the last peak in 2011 when companies acquired others for growth and for growth sakes, but the return on capital was lower than the cost of capital, which left a legacy of over $80 billon of writedowns when gold prices crashed. A decade later, a chastened industry is looking for value-added acquisitions such as Kirkland Lake’s $4.9 billion acquisition of Detour to boost its reserve profile or Teranga’s acquisition of high-grade Massawa from Barrick. The industry has returned to fundamentals and dividends are part of the new mantra. Among the seniors, we like Barrick Gold, Agnico Eagle and B2Gold. We also favour Lundin Gold and view Centamin, Centerra and Eldorado as potential M&A targets in the next gold run. Developers are well-placed like Osisko Mining, Sabina Gold & Silver or McEwen Mining with projects that can be brought into production in the current gold cycle. Further, we view the exploration players as the next beneficiaries of the coming cash flow bonanza of higher gold prices. Drill baby, drill.

Agnico Eagle Mines Ltd. (NYSE/TSX: AEM) – Agnico produced 330,000 ounces in the second quarter enabling it to meet guidance at 1.68 million to 1.73 million ounces. In Nunavut, Meliadine’s mill throughput increased to 4,300 tpd and should top 4,600 tpd after a filter press is installed. At Kittila in Finland, the receipt of a permit allowed an expansion of the processing facility to 2 million tonnes per year as reserves and resource gets bigger. At the Canadian Malartic joint venture, Agnico has 10 drills turning at the East Gouldie deposit. Results are expected shortly which will allow an update of the resource. Agnico and Newmont have formed a 50/50 joint venture to explore a 200 km in Northern Colombia. We like Agnico here for its organic growth from mines in Canada, Finland and Mexico. Buy

B2Gold Corp. (TSX: BTO) – B2Gold’s Fekola mill expansion will increase production by 1.5 million tonnes per annum. Fekola in Mali produced 147,000 ounces in the second quarter at a cash cost of only $300 an ounce, which is a large part of B2Gold’s total production of 257,000 ounces. B2Gold is a low cost operator, with cash flow of $238 million in the quarter enabling it to finance Gramalote, a 50/50 joint venture with AngloGold Ashanti in Colombia. A feasibility study is expected in the first quarter next year, building on a PEA that outlined 400,000 ounces a year from an open-pit at AISC of $648 an ounce. B2Gold shares weakened recently because of a military coup in Mali, but the mine was unaffected. We would take advantage of the pullback and Buy.

Barrick Gold Corp. (NYSE: GOLD; TSX: ABX) – Barrick met its targeted $1.5 billion non-core asset disposal program, boosting free cash flow and with efficiencies at core asset Nevada Gold Mine Joint Venture, cash costs shrunk to $716 an ounce. At refreshed Hemlo, Barrick transitioned to an underground contracting model and the gold district is having a sorely needed second look. After sorting out problems with a new agreement with the Tanzanian government, Barrick and joint venture partner Zijin is teeing off with the Papua New Guinea government by placing Porgera on care and maintenance while negotiations take place. Hopefully this too should pass. The world’s second largest gold producer has become a cash machine, producing 5 million ounces or so at AISC under $1,000 an ounce. Barrick is one of the most profitable around with an enviable array of core assets and excellent management. Buy.

Centerra Inc. (TSX: CG) – Centerra produced 220,000 ounces of gold in the quarter, generating $169 million of positive free cash flow with Kumtor producing 170,000 ounces at a cost of $692 an ounce. Recently commissioned Oksut in Turkey produced 12,000 ounces at $393 an ounce, which was a stub quarter. Centerra has cash of $212 million with total liquidity of $712 million sufficient to handle $415 million of spending this year. Centerra is an intermediate producer with a flat production profile from its mines in Kyrgyzstan, Canada and Turkey. However, the company has a flat production profile, which is in harvest mode and thus we prefer more growth oriented B2Gold here.

Eldorado Gold Corp. (TSX: ELD) – Eldorado produced 138,000 ounces in the quarter at AISC of $859 per ounce. Guidance was maintained at 520,000 to 550,000 ounces with AISC between $850 and $950 per ounce. Eldorado produced free cash flow of $63 million finishing the quarter with $440 million in cash and equivalents. At Kisladag in Turkey, output was 20% higher than the first quarter due to better weather. An update at Lamaque in Quebec is expected by year-end which will include upgrades of the Sigma mill and details of the nearby Triangle deposit. Close-by is the Ormaque discovery which could help the assessment. At Olympias in Greece, output increased slightly and development continues at Skouries. Eldorado’s dilemma is that their mines do not generate enough cash flow to finance the $900 million required to bring Skouries and Perama Hill into production. Consequently, Eldorado would be a nice tidbit for a major looking to boost output. Eldorado is a Hold for future M&A action.

IAMGold Corp. (NYSE: IAG; TSX: IMG) – Mid-tier IAMGold produced 155,000 ounces due to contributions from Essakane and Rosebel, however AISC was over $1,100 an ounce. IAMGold also surprised the Street by lowering guidance to 645,000 to 700,000 ounces because of expected shortfalls from Rosebel with a boost in all-in-costs to over $1,200 an ounces. Rosebel in Suriname produced 52,000 ounces with first ore material from Saramacca in the quarter. The shortfall was attributable to Covid-19 and a strike.

Production at trouble-prone Westwood was a paltry 20,000 ounces and reserves were slashed 48%. IAMGold now plans a slower ramp-up to 100,000 to 125,000 ounces but they will have to develop more reserves. Meantime, IAMGold is betting the farm on joint venture Côté, which has a $900 million price tag. We believe there is little on the horizon and thus this high cost producer could stub its toes again, since Côté is a big bet. Sell.

Kinross Gold Corp. (NYSE: KGC; TSX: K) – Kinross had a decent second quarter generating $220 million free cash flow and producing 572,000 ounces. At Tasiast in Mauritania, mill throughput was 16,700 tpd, which is expected to increase to 21,000 tpd by the end of 2021. However Tasiast production near term was affected by Covid-19 and a 17-day strike. Longer term the mine plan is being reviewed but the schedule remains. At Kupol in Russia, exploration continues with a reserve update expected at year-end which will extend Kupol’s mine life as it switches to narrow vein mining. Kinross plans to spend $900 billion or most of their cash flow this year at Kupol and Tasiast, which is manageable because of their balance sheet. In the interim however, Kinross has a flat to declining production profile because the Kupol expansion and recently acquired Chulbatkan won’t be in production until 2023. Kinross’ shares trade at a discount to its peers due to its Russian exposure. We thus prefer B2Gold for its growth and geographic profile.

Lundin Gold Inc. (TSX: LUG) – Lundin Gold’s Fruta del Norte (FDN) is back up and running with the mill processing stockpiled ore. Production guidance for the last half of the year is expected at 165,000 ounces at AISC of $800 per ounce. Fruta del Norte’s is one of the world’s richest gold mines and should produce 300,000 ounces or so next year with free cash flow of $300 million plus. The company will spend $5 million on exploring their highly prospective land package of 29 mining concessions, covering some 70,000 hectares of land, beginning with Barbasco and hopes to spend double that that next year. We like the shares here, particularly for their exploration upside, which we recall from Dr. Keith Barron, discoverer of FDN, as highly prospective. Buy.

Newmont Corp. (NYSE: NEM; TSX: NGT) – Newmont produced 1.3 million ounces at AISC of $1,097 per ounce. The largest gold producer in the world, with a portfolio of 12 operating mines and two joint ventures with Barrick is capable of producing 6 million ounces a year for most of this decade, generating free cash flow of a billion dollars plus a year for the next five years. In the last quarter, Newmont restarted three sites, focusing on turning around Goldcorp’s Eleonore in Quebec and Penasquito in Mexico. In South America, Newmont focused on developing Yanacocha’s sulphides to extend their flagship’s life. Newmont has a strong balance sheet with $6.7 billion of liquidity. While Newmont is considered a core stock, we prefer more potential growth-oriented and lower cost Barrick.

Yamana Gold Inc. (NYSE: AUY; TSX: YRI) – Yamana produced 164,000 ounces in the quarter with a solid contribution from Jacobina (46,000 ounces) and joint venture Canadian Malartic. An update to expand Jacobina was tabled which will cost $57 million to boost output 30%. Yamana plans to list on the London Stock Exchange to broaden shareholder reach but we note that London Exchange players support mostly African plays. Earlier, many mines left London and switched to North American exchanges because of a broader market and prohibitive listing costs. We think the move is more arm-waving than substantive since Yamana’s problem is not shareholder recognition, but too high debt and high cost mines. Sell.

Editor’s Note: This is an edited version of Maison Placements Canada client report, prepared by John Ing, President and CEO of Maison Placements Canada. Maison, a Toronto-based investment dealer, provides a comprehensive array of financial services to institutional investors and small to midsize corporate clients. For more information on Maison Placements Canada, visit www.maisonplacements.com.

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