Gold investors aren’t complaining.
The precious metal has surged over 20% this year, with punters banking huge profits.
The Vaneck Gold Miners ETF [ASX:GDX] has pretty much doubled from its low of $17.99 per unit on 20 January. GDX tracks the overall performance of gold miners, where 55.4% of the companies are listed Canadian stocks. In other words, the gold euphoria has gone global.
Back home, Northern Star Resources [ASX:NST] — one of Australia’s most profitable gold miners — has jumped nearly 100% this year. In the March quarter, Northern Star generated operating cash flow of AU$103 million. It boasts a low breakeven cost of AU$985 an ounce.
Silver Lake Resources [ASX:SLR] is another success story. Its share price has jumped nearly 200% since January 20. This is a classic higher risk, higher reward story. Silver Lake’s breakeven price stands at AU$1,254 per ounce. This sounds pretty good, with the gold price trading at roughly AU$1,750 per ounce.
But is the gold price rally sustainable?
I don’t think so. If I’m right, gold mining profit margins should shrink in the months ahead. This won’t bode well for investors, who will be left wondering why they didn’t sell near the top.
Ignore the mainstream
Investment banks and the mainstream media are wrong on gold. Following the recent surge in the gold price, CNBC reported last week:
‘Wall Street’s largest banks [are] flocking to the yellow metal.
‘“We’re recommending our clients to position for a new and very long bull market for gold,” JPMorgan Private Bank’s Solita Marcelli said Tuesday on CNBC’s “Futures Now.” After seeing three back-to-back years of losses, the precious metal has rallied 20 percent in 2016. And that’s just the start of the next leg higher, according to Marcelli. “$1,400 is very much in the cards this year.”
‘“Gold is looking more and more attractive every single day,” concluded Marcelli. “As a nonyielding asset, it has a minimal storage cost, so when you compare it to negative-yielding assets, it actually has a positive carry.”’
Someone has to say it: JP Morgan’s forecasting record is atrocious.
Remember, JP Morgan couldn’t and didn’t forecast the Global Financial Crisis of 2008/09. In fact, it had to get bailed out by the US government — it was that wrong. Investment banks are notorious for being bullish. To an extent, they have to be. If they aren’t, their clients — blue chip companies — will do business with someone who is bullish on them.
The mainstream media has an even worse track record. The mainstream is an alarmist trend follower. When stocks rise, they’re very bullish. When they fall, they’re very bearish. I explained on Monday that voices in the mainstream called gold a ‘pet rock’ at the low in July 2015. Of course, with the change in trend, the mainstream has turned bullish.
Here’s a good rule: when the mainstream is bullish, you should be bearish. And vice versa. It takes an open mind and objective analysis to see through their rubbish, which we call news.
Negative rates in the US…you’re dreaming
I received an email from a Resource Speculator reader on gold. He shared an article from The Oxford Club — a company under the Agora umbrella, which Port Phillip Publishing is also a member of. Sean Brodrick, Resource Strategist, wrote the following:
‘A strong dollar has killed U.S. exports. The Fed also realizes the U.S. and global economies would wither under higher borrowing costs.
‘Bottom line: U.S. interest rates will stay low. And low rates at home and abroad lift a tremendous weight off of gold.
‘And if the rumors are true and the Fed is considering negative interest rates, that’s even better news for gold.
‘Gold has enjoyed a great run this year. But that run isn’t over. Pullbacks can be bought.’
Clearly, I don’t agree with Sean’s research. The US dollar has weakened in the last couple of months. After it hit a high of US$1.00 in December, the US Dollar Index has pulled back to around 94.64 US cents. The correction helped US corporate earnings, with the Financial Times reporting:
‘So far, though, nearly three-quarters of the companies that have reported have surprised investors with higher than forecast earnings, above the five-year average of 67 per cent.’
Of course, the dollar pullback won’t last. It’s the best looking currency in the world. When the reserve currency breaks out higher, it will hurt US corporate earnings. In the meantime, it’s crucial to understand how the dollar correction has assisted the gold bear market rally.
Remember, gold has surged due to a change in sentiment. In December, the US Fed announced it would raise interest rates four times in 2016. Following a stock market correction and global banking concerns, the Fed back flipped on its hawkish stance. The price of gold skyrocketed — punters saw the yellow metal as a ‘safe haven’, with the US dollar sold off.
As it stands, the US Fed plans to hike rates twice this year. It won’t move to negative rates any time soon. Fortune.com elaborated last week:
‘Federal Reserve Chair Janet Yellen said on Thursday that while she “would not completely rule out the use of negative interest rates in some future very adverse scenario,” the tool would need a lot more study before it could be used in the United States.
‘Yellen, in responses to written questions from U.S. Congressman Brad Sherman following her February testimony on Capitol Hill, said the Fed plans to raise interest rates gradually, given its expectations that the economy will continue to strengthen and inflation will move back up to the Fed’s 2% goal. She also said that if the economy unexpectedly takes a turn for the worse, the Fed will adjust its stance.’
Indeed, notice the words, ‘future very adverse scenario’? The Fed’s nowhere close to negative rates. There’s little global concern at the moment. So, it plans to hike rates. When this happens, gold stocks are likely to get hit hard.
Will the US Fed raise rates in June?
The next rate hike could be closer than we think…
‘Interest rates are too low for the current U.S. economy,’ Kansas City Fed President Esther George told CNBC last Thursday. Esther George is a voting member. She backs gradual rate hikes, and thinks low rates can create economic risks.
George is dead right. Low rates will lead to a pension crisis around the world. Pension funds are underfunded, to the point they are starting to collapse.
Boston Fed President Eric Rosengren and Cleveland Fed President Loretta Mester — both voting members — both stand for higher rates. According to CNBC, the two figureheads said the ‘markets are underestimating the pace of potential hikes, and that uncertainty should not prevent the Fed from acting on policy changes.’
Rosengren added he is, ‘concerned about the costs of rates staying too low for too long. April job growth of 160,000 positions still looked relatively strong despite falling short of estimates.’
With the US economic outlook ‘definitely looking good,’ the US central bank is on the cusp of raising rates. That’s what San Francisco Federal Reserve Bank President John Williams said at the Sacramento Economic Forum last Friday.
‘I view the balancing act as very similar to the balancing act that kind of led to the first rate increase. … We have to be making the decision. Do we want to wait a little longer or act now?’ Williams said, according to Reuters.
The bond market remains sceptical.
Interest rate futures show a rate hike next month stand at 8%. The number compares to 46% a month ago.
It appears punters are wearing rose coloured glasses.
US retail sales grew last month, and at the fastest pace in more than a year. The economic conditions are ready for another rate hike.
If the Fed does move towards lift off next month, expect gold stocks to crash.
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Resources Analyst, Resource Speculator
Ed Note: This article was originally published in Money Morning.