Investment Strategy: Highlights Precious Metals
- Long term macroeconomic trends, as well as supply-demand factors are highly favorable to precious metals for the foreseeable future.
- Gold stocks offer greater leverage on a bull market in gold than bullion.
Supply / Demand Forces
On the demand side, China and India remain - to a large degree - the world’s largest buyers of gold. This demand for gold is endemic to the culture and will always be present. As these economies grow and the middle class attains more wealth, the demand for gold and investment alternates such as platinum will remain robust. It is often the case that when gold prices spike, purchasing of gold is delayed and potential purchasers will buy silver or platinum instead. Thus, a strategy of investing in the whole precious metals complex, rather than exclusively gold, makes sense as it provides greater opportunity and stability to the investment portfolio.
On the supply side, it is well-known that gold production has flattened in recent years with no significant additions to supply coming on the market in the next decade. The reasons for this are as follows:
During the last bull run in gold (2008-2011) many gold producers had begun expanding, taking on significant debt as they initiated new projects. During the subsequent decline in gold prices (2012-2015) these companies found themselves over-leveraged and had to divest or discontinue exploration and development. As a consequence, with few development projects initiated between 2012 and 2017, the world found itself in a position where there was simply not enough gold mines in development to meet prospective future demand. This is because taking a mine from discovery to production typically takes more than a decade to accomplish. Thus, we can project a significant disequilibrium between the demand and supply in the current decade.
As a result, capital is beginning to find its way into the financing of gold exploration and development projects. Large and intermediate producers are looking to expand and are embarking on new exploration projects as well as the acquisition of junior exploration companies, particularly those with large with large reserves. In brief, the industry is ‘hot’ again. Yet when compared to their previous peak in 2011, gold stocks remain comparatively undervalued from a long term perspective. As a result, we can expect this bull trend in gold stocks to continue for many years to come, particularly when we consider macroeconomic variables. From a microeconomic perspective, with capital at historically cheap levels, as well as a cheaper input costs (primarily diesel fuel), the cost of exploration and development of new gold projects has decreased, thereby making gold producers more profitable.
The macroeconomics of the gold market are equally, if not even more compelling.
- Yields on government bonds have collapsed as Central Banks around the world continue to print money in the hopes of spurring growth and exports. This has led to a devaluation of global currencies and a case of foreign investors being forced to place investment capital in the ‘least worst of all’.
- Real economic growth has not returned to the global economy. Instead, we have experienced global stagnation. As a result, companies have engaged in buying back their equity (financed by cheap debt) rather than reinvesting in their enterprises. With limited prospects for growth investors are beginning to shy away from inflated equity markets. This capital needs to find a home.
- Astute investors recognize that we have entered an era of global stagnation, similar to what Japan has been experiencing since 1990. As a result, investors are far more interested in preservation of capital than they are in chasing beta in an increasingly unstable, yet stagnant global economy. Investment in government treasuries bears its own risk since nations continue to devalue their currencies through dovish monetary policy. In fact, since devaluation of a nation’s currency is a means of paying off debt, there is significant incentive for countries to continue their current trend of currency devaluation. Precious metals remain the most well-regarded hedge against currency devaluation.
Few people pay much attention to market liquidity, yet it is a major cause for market collapse. Commentators on the nightly news will tell you that markets are declining for whatever easily digestible reason, but the truth of the matter is that any sudden market collapse is precipitated by leverage, the ability to meet debt obligations and, ultimately, on the availability of both market and funding liquidity.
The chart below illustrates the wide range of policy tools that America’s central bank – the Federal Reserve – has implemented as a response to the current crisis in order to stabilize various parts of financial markets and the economy by providing liquidity.
As you can see, the complexity of the Federal Reserve’s response can be highly confusing. However, understanding how the Central Bank responds to financial and economic stresses will help you understand where money (and credit) are flowing; this flow of capital influences inflationary or deflationary forces which can collapse or increase asset prices. If you can understand this, you are ahead of other traders and investors who are looking for signs of recovery before taking a position.
That said, these monetary factors are only a part of the broader macro environment which impacts asset prices. Indeed, there are various factors that play a role in moving markets – these elements can be mapped, analysed and understood so that informed decisions can be made about appropriate positioning.
If you would like to understand how to use global macro, including liquidity and its effect on the financial markets, email us.
Let us know your questions at: firstname.lastname@example.org .
So the writing was on the wall. We discussed this last summer: keep a lot of cash and wait for the next big opportunity. What nobody could predict was the catalyst for the fall. In fact, we had a perfect storm brewing with 2 major catalysts. First, the COVID 19 outbreak: and the media has done a fine job in ensuring this particular outbreak will scare the crap out of any investor. Secondly: the Opec / Russia production increase. But perhaps this was more predictable...
Forget anything you may hear in the media about OPEC trying to gain market share. Crude is a commodity, not a brand name. Market share is gained or lost the moment one sells cheaper than one's competitor. What one needs to recognize is that oil is a political commodity. By not agreeing to production cuts, but rather to an increase when demand is plummeting at the height of a global pandemic, these two countries are achieving something quite different. It's irrational in economic terms, and when something doesn't make economic sense, one needs to question what's really going on.
This massive drop in the price of crude might hurt Russia in the short term, but it will give Russia much more leverage going forward. North American oil producers will suffer tremendously from this most recent price drop. Many of these shale producers are leveraged to the maximum. And with crude below $45, the marginal cost in the oil sands, production will stop. Europe will now be even more dependent upon Russian imports and the USA will begin to lose its strategic leverage in Europe. That's the intention anyway.
Now, as investors and traders, we have what could be one of the greatest opportunities of the century. Without making predictions about the stock market or the price of crude, let's consider how best to approach this. First of all, The oil price will likely remain low until it is no longer politically advantageous for Russia to keep producing. So one should pay close attention to political events that concern Europe, Russia and of course the USA.
Secondly, consider when the corona virus is likely to peak in the USA. If one considers how unprepared the USA was for this catastrophe, we can expect far more deaths in the USA than have occurred in China. The market may have recovered somewhat in the past few days, but the peak of this virus outbreak is expect in about 2 to 3 weeks. That could send the market back down to levels not seen since the financial crisis of 2008. This is not a prediction, just a caution. Certainly, there are bargains in the market, but I think people are being a bit naive thinking that the market will suddenly bounce back. It may retrace from here about 50% of its move down, but longer term, this event is going to affect the psyche of many people.
Be prepared for a very bumpy ride ahead. If the American government does things right - which is unlikely - we might see a recovery in the late summer. But if I were making a bet, I would say that there is more risk on the downside than opportunity on the upside between now and the end of summer. It is highly probably that the events of the past few weeks will put the world into a recession. If this happens, any rally in stocks should be considered an opportunity to sell.
If you are ready to venture into these murky turbulent waters, we suggest you look at some quality utilities that will continue to generate revenues. We would avoid banks for now because the risk vs reward ratio isn't attractive. With so many leveraged to the teeth on their mortgages and with so many bank loans in the oil patch, we would look elsewhere. Gold stocks and pharma stocks are two areas we like. Among the golds, we would suggest you look at the stocks which popped the most from the lows of this past week; companies with large and growing reserves in politically safe jurisdictions. We wouldn't look at the majors, but mid-tier companies and those companies involved in platinum and palladium. Impala, Gran Colombia, Osisko Mining and Osisko Royalties. Among the smaller companies, we like Balmoral, Victoria Gold, Great Bear, Midas Gold and Unigold. In the oil patch, we would consider Petrobras, but avoid any Canadian producers. They aren't coming back anytime soon if we have a recession. Good luck.
As inflation in China and India accelerates we are seeing a strong trend in the gold price. There is still a lot of opportunity in this market and we will show you some of the best ways to participate, with a potential of 100% + gains over the next year.
First, consider that India and China are the world's 2 largest gold buyers. And although higher prices in gold may curtail gold purchases in the short term, accelerating wage gains and growth in those economies support the long term trend up. (See charts below and compare inflation in those economies with the gold price. The correlation is strong, to say the least.)
The best way to profit from this trend is in gold stocks. Ideally, one should invest in junior growth stocks in late development stage and close to production and those whose resource estimates continue to grow. We also like a few select royalty streaming firms to balance out the portfolio. For those who took our advice in early summer and invested in Great Bear Resources, they would have made over 150%. https://www.onlinefinanceacademy.com/global-macro/follow-the-money
Here are a few more stocks that look like good value and that we consider to have significant upside: Argonaut Gold, McEwen Mining, Premier Gold Mines, Osisko Gold Royalties. Sprott Inc. is also cheap at this time and should be considered. On the more speculative side, here are a few stocks with enormous potential (although a few have made strong moves recently): QMX Gold, Monarch Gold Corp, Balmoral Resources.
* Disclaimer: Some of us at OFA may hold positions in some of these companies.
Perhaps there are people shaking their heads wondering why gold dropped today, not by a huge amount, but enough to look like perhaps a retracement from recent gains was taking shape. Consider its recent trajectory: only up. We mentioned in a recent post to private clients that we were in the FOMO zone (fear of missing out) and that would inevitably lead to rapid pullbacks. If you are long term investor, as you should be, this is an opportune time to wait for the next basing action.
So, why did gold go down today? Quite simply, the markets of late have been all about the trade deal with China. So news comes out on the wire about renewing trade talks in October, combined with a positive jobs report, well, this is all very bullish for the USA, and by extension, the US dollar. Traditionally, whatever is good for the USD is bad for gold: the inverse correlation between these two is well-established.
To understand the importance of this trade deal one need look no further than the base metals markets today. After the past few months of tailspinning they received a good boost today. This is not just a deadcat bounce. The base metals are way oversold and should a trade deal materialize we will see them go back up much further yet. But why many will ask.
First, let us dispel any erroneous ideas about the Trump Plan. Believe it or not, he has a plan, and although he may appear to be a buffon, and perhaps he is, he knows American voters far better than the DNC. IN fact, he will quite likely win the coming election. The DNC will not allow a left leaning democrat like Sanders to run, and ditto for a peace candidate like Tulsi Gabbard. In all likelihood, it will be a contest between Warren and Biden, and if Biden wins the nomination, he will lose to Trump. One should not pay too much attention to the press. Travel through the heartland of America and speak with everyone, not just white Christians, you will see Trump has broad support, and this includes latinos and women.
So imagine now the following: a trade deal materializes (liekly since Trump is planning for this to coincide with the election) and interest rates maintain their current level. Companies will reinvest in capex projects and we may very well see new and significant jobs growth in the first half of 2020, conveniently, just before the next election in November.
So, getting back to our investment strategy. Should we short gold and wait for lower prices ahead to get back on? I really don't think so. The macro situation continues to support gold over the long run. Should we invest in base metals stocks and copper at current prices? I would say yes. They are oversold and the price of lumber and copper suggest that there is still adequate demand in the housing markets. Should we buy more gold as it declines? I would wait. There are 2 solid technical levels below us ($1450, $1360). We would like to see a test of them. If we see that, definitely accumulate more gold, especially gold stocks.
Finally, does this scenario above mean that we are retracting our belief that the economy is headed for tough times? Absolutely not. The economy is impossible to predict, primarily because we our reactions to news and statistics prevents such predicted outcomes from occurring. Europe and much of the world remain in economic limbo, and it appears the global economy is resembling Japan (circa 1990) more and more. That means we can expect a future of perma-low interest rates, intentional weakening of currencies to maintain trade advantages and a continual destruction of buying power. In such a situation, one needs to be long gold and other PMs, especially platinum.
.Here is some key data to pay attention to, especially if you are still very long stocks and believe the last couple of weeks is just another of many more buying opportunities to come. As well, in this post we will look at some ideas which may look like a screaming buy in 2 years time. (One needs to be patient for the big big money move!)
First of all, recent reports out of Asia confirm that many people are paying (and receiving) with credit, IOUs and the like, just to keep afloat. Trump's tariffs are having the expected effect curtailing growth in the Asian market. This has killed bellwether stocks such as Samsung. At the same time, we see East Europe is supplying more of what China once offered far more cheaply. No doubt, a trade war is in effect and the result of such trade wars lead to currency debasement.
All this is good (slash that) great for the gold market and eventually will be for high yielding stocks. So far, many of these high yielding stocks have retraced significantly with the general market. Ditto for energy stocks. For those who took advantage of our advice on going long gold and platinum 2 months ago, we would suggest to continue to buy on retracements; this bull trend is far from over. A global governments race to zero interest rates a storm is brewing.
We would also suggest that you consider shorting high yield debt and instead go long certain high yielding equities, such as pipeline partnerships (AMLP), as well as select oil stocks. We realize this last idea is very much a contrarian trade, but how often is it that you find oil companies trading at about 4 times cash flow (half of what is typical), below book value, providing good dividends and which are still profitable? If WTI stays below the $50 handle, which it no doubt will if trade conditions deteriorate, producers will cut back on production. Currently, there is a glut of production, so it is only a matter of time before the pendulum swings back. Right now though, things are looking pretty cheap.
Shorting stocks is always a bit tricky, especially when lousy companies with little or no prospect of ever turning a profit continue to attract capital. A classic case would be UBER which today reported a loss of over 5 billion on revenues of slightly more than 3 billion. Yes, that's correct. These numbers make no sense even if one considers the majority of that loss was due to incentives given to original stakeholders. Imagine you're a 7 year old who opens a lemonade stand and you sell it for 30 cents a glass, while it costs you 50 cents to make. Really, it's not much different from that. And if your argument is that you are trying to capture market share with your brand and your app, think again. The fact that this company and others like it are even able to attract capital is absurd in historical context. Here is a stock with no moat around it, no potential for any significant profit margins, and a lousy corporate governance. There is far more money than brains involved in the market now, perhaps because it's not real money, it's just debt. All this is very reminiscent of 1999. Hold onto your hats. One can't predict the future of course, but we would suggest staying nimble, stay in gold and cash, and wait for greater opportunities ahead. Remember, nobody is forcing you to make a trade. Buy when there is blood in the streets!
Gold: where are we headed?
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