The gold price and gold mining equities seem to have been going through something of a correction over the last six months. What is your view on why this has occurred?
One of the key things that happened with the onset of the pandemic was you saw central banks around the world slash interest rates. Real rates fell very quickly and that in turn was positive for gold. We always tell investors, you can look at a million different factors when it comes to gold prices, but the one that seems to have the best correlation historically, or at least in recent history, has been real rates in the U.S. The lower the real rate goes, the higher the gold prices are – and vice versa.
What we saw through the summer of last year was real rates kept getting lower because the U.S. Fed slashed interest rates to near zero, inflation expectations kept increasing with increased fiscal stimulus and so you saw gold prices hit all-time highs in August – just a little north of US$2,000 an ounce. What has happened since then is obviously gold prices have declined by about 16%, and now we’re just a little north of $1,700 an ounce, which is still a very good gold price for the producers.
Are there other macro factors that play into that as well, like inflation returning or idea of gold as a hedge, and then eventually that trickling down into wanting to own mining equities as a result?
Inflation expectation or hedging against inflation is probably the main reason you saw investors pile into gold last year, and you’re still seeing positioning this year. I think inflation expectations versus real-world inflation data that we’ll see in the second half of this year, there could be a disconnect. For example, the U.S. side is saying they see just a little north of 2% inflation later this year. But practically speaking, if you look at everyday life, whether it’s things you buy or costs of travel, et cetera, if you look up these prices, you can see that the real world inflation data suggests it could be much higher than that. I think if you get into the second half of this year, there’s a good chance that you’ll see real-world inflation data that’s actually a lot higher than the Fed’s expectation. And again, that would be positive for gold.
Our view for this year is that gold will average about US$1,900 an ounce. Again, today we’re at little north of US$1,700. So obviously we’re more bullish on gold. And the basis of that is this idea that real inflation data will be a lot higher than what people are expecting. And that will continue to push down real rates and continue to push gold higher.
Furthermore, when economies reopen, particularly in India and China, you’re going to see physical demand. Jewellery demand according to the World Gold Council last year was extremely weak. And it rebounded just in the last little bit of 2020. But I think it could be a lot stronger in 2021. You have central bank demand, jewellery demand that could really pick up as economies reopen in the second half of this year. It’s something people don’t really talk about, but it’s important to know that about 50% of physical gold demand is jewellery demand.
Gold companies have been doing really well in terms of keeping cost discipline. But there’s got to be a lot of M&A on the horizon or certainly plans to add ounces through acquisition. Do you have a view on how you see it picking up or will it be steady? Will it be steep?
I think the M&A theme is going to play out this year. Some of the companies looking to acquire will find targets look a bit more attractive from a valuation perspective
But there’s an expense to that. And the expense to that is that you are in some way sacrificing your reserve replacement maybe a few years from now. There was a bit of a pass for 2020 because a lot of these companies couldn’t do as much exploration or drilling activity as they wanted because of COVID restrictions. But I think this year there’s going to be a lot more focus on it. And part of the solution is exploring and hoping that you continue to find more ounces.
So, the gold price is conducive to M&A I think, reserve replacement challenge becoming more of a focus is conducive to M&A. Now the question of where does the M&A happen? I don’t really think you’re going to see mega mergers. I think it’ll be more asset acquisitions or medium-sized companies combining to get larger. That’s a theme that I expected to play out last year as well.
Silver markets had an interesting period recently with the short-selling Reddit agenda, and seemed to withstand it. But the price has moved up and has stabilized in the high twenties. It’s looking to be another interesting angle for investors looking for exposure to precious metals as well, not just physical silver, but silver and gold miners as well.
Just as a caveat, most of my time and coverage is spent on gold and then most of the gold companies I cover they also produce silver as a by-product. So, of course I do look at the market, but I’m not necessarily a silver expert. But let me just say this: the demand profile for silver is very different than for gold. I mentioned earlier that 50% of gold demand is jewellery demand. The marginal demand that really moves gold prices is investment demand. For silver, the vast majority of demand is industrial demand. And it’s just a different dynamic. It’s more closely tied to GDP growth in certain countries, the U.S. and China for example.
There’s also an element of a green transition in there. For example, silver is used in solar panels, so that factors into the equation as well. But, broadly speaking, silver is going to follow what gold does. We’ve seen that historically. So, watch industrial demand this year and watch what gold prices do. I think that will be a good barometer for silver as well.
I want to get a view from you on how companies you analyse incorporate ESG and how you feel they’re progressing and moving with this evolving landscape.
As you mention, the landscape is changing very quickly and the standards are changing, investor expectations are changing. A number of gold companies just in the past three months have set zero carbon emissions by 2050. So net neutral or net zero by 2050. They’ve done that carbon reduction targets before then. So, let’s say 10% or 20% or 30% reduction by 2030, or committing to electrification of their fleet or using equipment that uses batteries instead of diesel. And then also committing to using more renewable power at the mine.
There’s an array of things that gold companies are doing, and they’ve only introduced these measures really in the past three to six months. And that’s pretty quick. Historically, the gold sector has been pretty behind when it comes to lowering carbon emissions and really thinking about climate change, even introducing kind of novel technologies because they go hand in hand if you introduce the kind of battery electric technology that also helps you reduce your environmental footprint and carbon emissions. The gold sector historically has been kind of slow to adopt some of these measures, but the pace is picking up.
I ask investors what the 10 things they care about are when it comes to ESG. And it’s the obvious things that you would think about if you were investing in gold companies. What are your carbon emissions? What’s your water usage? What is your relationship with indigenous groups or local communities? What is your safety record? What are the tailings dams designs that you have? These are just kind of the obvious things when it comes to ESG. Step away moment from all the different metrics that they’re reporting on, and really try to focus on these handful of key things that miners should be doing a better job of, to actually be better on ESG, not just what they report, but how they actually perform.
So, clearly, it’s something that matters to these management teams and they’re prioritizing it because their investors care about it. If you’re a resource portfolio manager and you’re investing in gold because of an inflation hedge where you think gold is going to go up, or you want to have exposure, or it’s always been part of your portfolio, you’re applying ESG screens to it too. I think there’s a long way to go, but I certainly am encouraged by the recent developments. And just over the past six months has been quite quick.
Mining companies have endured and commodities have done well throughout the pandemic year for a multitude of reasons. But do you think the lack of travel and the inability for investors to get to sites has slowed down deal flow enough that we could expect a lot more investment into gold mining companies later this year?
Most people have adjusted pretty quickly to the virtual environment. And yes, I’ve seen virtual mine tours, for example. It’s not the same as visiting a mine, but I think over the last year more investors have gone in front of more management teams than they would have before. Why? Because a management team now can do many more virtual conversations and they could necessarily physically going to a conference and being in a room.
Where I think the whole virtual pandemic issue has had more of an impact is on M&A from a due diligenCOce perspective. Companies have found ways around that, such as private travel, and it’s opened up a little bit. So due diligence is more possible now than it was at the beginning of the pandemic. But I do think that has had an impact on deal flow as well. This has improved and I think it’ll get even better once things fully reopen.
