Joe Foster, Portfolio Manager and Strategist, VanEck, has written a note on the gold price, saying that lack of investor interest and misguided cost concerns have been fuelling underperformance in gold equity for some time.
He believes that now the market may be reaching a turning point. Gold equities outperformed gold bullion in March, as the NYSE Arca Gold Miners Index gained 2.9 per cent, while the MVIS Global Junior Gold Miners Index (MVGDXJTR) advanced 2.2 per cent.
Foster writes: “We are starting to see some reversals in the factors which have recently put investors off gold equities and there are perhaps signs that gold stocks are beginning to claw back the performance they lost relative to gold this year.”
There are several reasons for gold’s recent underperformance, Foster says.
“Since the Fed began raising rates in December 2015, the gold market has shown weakness in the weeks ahead of each rate decision. This pattern was repeated once again in March, as the low for the month was USD1,306 per ounce on March 21, the day the Fed announced its sixth 0.25 per cent rate increase since it began raising rates. The next FOMC meeting is under a week away and, with many predicting that the FED will be more aggressive than anticipated and raise rates four times in 2018, gold could show further weakness.
“While stock market volatility has returned to markets this year, it has yet to reach worrying levels that might motivate investors to hedge their exposure. General investor apathy towards the miners has been evident for some time, with anecdotal evidence suggesting that institutional investor interest in precious metals was at levels last seen in the early 2000s, before gold’s bull market. However, should the Fed begin to raise rates more aggressively, investors may get nervous about how successfully it can marry policy to rising inflation expectations without the US economy taking a hit. Gold may once again emerge as the safe-haven of choice.”
The early February general market sell-off has been viewed by investors as an overdue correction, rather than the re-emergence of systemic risks, Foster says.
“This interpretation precluded a flight to safe-havens, causing gold and especially gold stocks to sell-off with the market in early February. As a result, gold producers are trading at a roughly 20 per cent discount to their historic valuations. So far, the general sell-off has been too short to benefit safe havens. According to recent research, it usually takes a month or so of equity drawdown for gold to start to act like a hedge.”
Several companies have suggested that mining costs will be higher in 2018, rising to around USD925 per ounce from current levels of around USD900, Foster reports.
“This represents an unwelcome increase, as mining costs have fallen roughly 25 per cent to around the USD900 per ounce level since 2012. However, based on company guidance so far, we believe these concerns are somewhat overblown and that costs will fluctuate around the USD900 level for the foreseeable future. There are several reasons for this, namely that many companies have long-term contracts for materials and consumables and some have hedged fuel and currencies at low levels. Concerns over rising costs therefore should not put off investors. Under the right conditions, it probably won’t take long for the global gold mining sector to fill the valuation gap and regain its historic beta to gold.”
