Against a backdrop of negative real interest rates and loose monetary policy, gold could glitter more brightly.
“We are positive on the outlook for gold,” says Gary Chapman, managing director of Canadian equity at Guardian Capital in Toronto. He’s maintained this outlook over the years and, despite not always being correct, “we remain predisposed toward gold and silver,” he says, noting that the two metals are highly correlated.
His combined weighting of gold and silver normally fluctuates around market weight, he says. But as of early May, he was somewhat underweight. That’s simply “a function of stock picking,” Chapman explains, “as we want to own only those companies with good growth prospects that have a good balance sheet and good cash flow to fund that growth.”
Chapman, whose firm is one of three that manages the Renaissance Canadian Growth Fund, also picks companies with below-average all-in sustaining costs — the cost of producing an ounce of gold plus the capital expenditures required to maintain production levels.
In addition to those considerations, current market forces are keeping him positive on both metals.
Negative rates, positive liquidity
First, “Most of the world has negative real interest rates,” says Chapman. “And parts of the world — Europe, for example — even have negative nominal rates, [which] should be good for gold.”
Secondly, “Central banks have undertaken very long periods of providing liquidity. And this liquidity — even in the U.S. where the Federal Reserve has already begun to raise rates — is nowhere near being sopped up. Excess money is good for gold.”
Chapman explains why: “Non-financial [sector] credit growth has been greater than GDP for close to two years. And this is good for gold, in that an improving economy from current tight labour markets should help along inflation.”
He’s aware that wage growth is about 2.5% to 2.9% and is positioned to increase, and that “the U.S. economy [is] tight, with low unemployment rates, continued job growth and very low jobless claims.” But he expects the Fed will avoid hurting economic recovery by raising rates slowly.
Given that, “This is an environment for inflation to run modestly above interest rates for some time,” and that “will result in that upper bias to gold.”
Even as macroeconomics points to rising gold prices, what’s key is gold prices also aren’t expected to drop, stresses Chapman. “This creates an environment to pick gold stocks — those [that] can do well in a flat or rising commodity environment.”
Indeed, as Bloomberg reports, gold is expected to extend recent gains to reach “a four-year high above $1,400 an ounce this year,” based on the Fed not stepping up “the pace of increases in borrowing costs.” (See current gold prices.)
Stocks that meet the gold standard
Chapman holds Eldorado Gold, Torex Gold Resources, Goldcorp and Tahoe Resources. “Each has growth, the ability to finance that growth, and below-average production costs,” he says.
For example, Eldorado has two mining developments in Greece — Olympias Phase II and Skouries — expected to start production in 2017 and 2019, respectively. “Production will go up 50% between now and 2020,” says Chapman. “And all-in sustaining costs should drop from the mid-$850-per-ounce range to sub-$600, which would be well below average.”
In addition, “Eldorado has a reserve life index that is 50% larger than the average company, and the balance sheet is plenty strong to finance this growth, with $850 million in cash, a $250 million undrawn revolver and $600-million debt not due until December 2020.”
Torex Gold Resources shows similar promise, with production at its El Limon-Guajes Mine underway since December 2015. “The company is guiding for north of 350,000 ounces per year at an all-in sustaining cost of around $800 an ounce […] for 2017,” says Chapman. Further, that cost has room to fall about $100 in 2018, he adds. On the same property, a second project, Media Luna, will use much of the same infrastructure, and should produce 500,000 to 600,000 ounces annually by 2021 or 2022.
For its part, Goldcorp has a five-year plan to increase production, improve reserves and lower costs, all by 20%. “While not in the bag,” says Chapman, “they have a realistic plan to get there.”