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Daniel Greenspan, CIBC Asset Management, senior analyst and resource team director.
What is the outlook for gold in a higher inflation end world? Before we get into that question specifically, I’ll take a moment to set the stage in terms of where we’ve been on the gold price in recent months.
Well, it certainly doesn’t feel like it, but the second quarter of the year actually saw the gold price strengthen by around 5%, from a low of $1,700 an ounce at the start of the quarter to $1,800 an ounce by mid-June.
That said, it was certainly not a straight line higher for prices, with a move through $1,900 an ounce in the quarter, before pullback on changing expectations around interest rate hikes in the coming years. Coincident with the higher move in the gold price quarter over quarter, the U.S. 10-year Treasury rate weakened by 15% over the quarter to 1.5% by mid-June.
Market sentiment now is certainly mixed on gold, with a healthy debate around the outlook for interest rates versus inflation expectations in the coming quarters and years.
So, that debate over inflation versus interest rates will be one of the key drivers for the gold price looking forward. The bullish case for gold centres around expectations that consumer demand has been pent up during the pandemic, and, now that global restrictions are eased, consumers will be coming back with savings in hand and demand for goods and services will outstrip supply and drive inflation.
At the same time, strengthened input costs are expected to be passed through to consumers and will drive inflation as well. Examples of these increases in costs can be seen across the commodity […], from energy prices and metal driving higher prices on consumer goods, to soft commodities like corn and soybeans driving prices higher for food.
The strength in commodity prices increases production costs for finished goods, which are expected to be passed on to consumers where possible, which drives higher inflation, which in a lower-interest rate world should be supportive for the gold price.
The flipside of the coin in the bullish case for gold is that inflation is transitory and is being driven by bottlenecks in the global supply chain, and that nominal interest rates will rise ahead of inflation and, as a result, real rates will rise which should be a headwind for gold.
So where to from here? A couple key questions will drive the medium-term outlook for gold, specifically, one, “What is the path higher for interest rates from here?” And two, “Is the inflation we’re seeing transitory or more sustained?”
On the first question, the recent Federal Reserve meeting in mid-June was more hawkish than expected. Seven of 18 policy-makers now expect a rate hike in 2022 versus four previously. Similarly, 13 to 18 policy-makers forecast at least one rate hike by the end of 2023, up from seven previously.
So, it appears that the path higher for interest rates is a bit sooner than the market previously expected.
On the second question regarding the transitory nature of inflation, rate hike expectations could signal to investors that inflation may be more persistent and higher than previously expected. While tighter supply chains certainly are helping with inflation now, we also think commodity prices and input costs generally remain supportive, which, along with consumer demand, could be a tailwind for inflation in the coming quarters and into next year. From here, we’ll continue to watch inflation versus nominal rates to get a sense for whether or not real rates will remain supportive for gold.
In our opinion, considering the depth of the uncertainty caused by the pandemic, we expect monetary and fiscal policy to err on the side of looseness, and therefore we expect the gold price to be supported in the second half of 2021 and into 2022.
In terms of the equity outlook, there are a couple of interesting opportunities in the gold sector. In the large-cap space, we view Newmont as a leader in the sector amongst the senior producers. We’ve seen Newmont as a high-quality gold producer with consistent operations, a credible pipeline of growth projects that can sustain production over the medium term. We like the company’s strong balance sheet and solid management team, and we’re comfortable with the geographic exposure. Newmont’s been a leader on capital allocation policies and has a strong ESG profile.
Barrick Gold is also a large-cap producer we view favourably. The stock has underperformed Newmont by almost 25% over the past year, as Newmont has taken the lead on capital allocation and strategy.
Barrick also has had a bit of an M&A overhang as the market awaits the company’s next transaction. While M&A risk is certainly still on the table, we give Barrick the benefit of the doubt on the transaction, given the history this management team has on acquiring assets and companies. We think that underperformance relative to Newmont is overdone, and we expect that Barrick could catch up and narrow the gap. We view Barrick as a low-cost consistent operator with exposure to tier one gold assets. The company has integrated recent transactions well, and, while there are risks around M&A, we recognize the stock offers good exposure in a strengthening gold price environment.
Finally, we also liked the outlook for Kirkland Lake Gold. This is a company with very low geographic risk exposure with all of its mines in Canada and Australia. The balance sheet is in great shape.
We see potential for optimization at their cornerstone asset Detour Lake, which is in Ontario, and we see a potential value driver for the stock over the medium term from optimizing that production. We also see potential for exploration success across the portfolio that can add amply to the company’s inventory.
Finally, the completion of the new shaft at their Macassa Mine, also in Ontario, can drive value for […] shareholders.
Looking into the mid-cap space, for investors interested in a bit of a higher risk/higher reward story, our top pick is Endeavour Mining. Endeavour is a West African gold producer with operations in Burkina Faso, Cote d’Ivoire and Senegal. The company has been in the acquisition stage of growth, and we believe that as it transitions to free cash flow, the stock will rerate to reflect the potential cash flow from the asset base. We view the management team at Endeavour as very strong, the internal project pipeline as credible, and we see exploration upside from the asset base. That said, we recognize the risks associated with working in higher-risk jurisdictions in West Africa.