Authored by Shree Kargutkar, Portfolio Manager, Sprott Asset Management LP
With the beginning of the new year, we have entered a seasonally strong period for gold bullion and gold equities. Gold bullion posted a strong gain of 3.23% in January, ending the month at $1,345.15 per ounce. While sentiment towards gold has improved from frigid to lukewarm, sentiment towards precious metals equities remains downright bearish.
We view this as a positive sign for precious metals equity investors with a long-term horizon because a shift in sentiment towards an asset class is usually followed by robust gains, which are primarily driven by re-rating of its valuation multiples. In the case of precious metals equities, multiples have continued to trend lower, making stocks cheaper while gold bullion has appreciated in price. We track investor positioning using a number of metrics including fund flows, gold futures trading and ETF flows. Gold bullion ETF flows serve as a good proxy for investor positioning, and options trading on GLD1 helps us to gauge sentiment. As shown in Figure 1, the shares outstanding in gold bullion ETFs are currently at a three-year high. When seen against the backdrop of rising asset prices, the increase in gold bullion holdings, is merely par for the course.
Figure 1: Total Known ETF Holdings of Gold (Oz) (1/2015 – 1/2018)
Source: Bloomberg. Data as of 1/26/2018.
Curiously, the shares outstanding in GDX,2 which is the largest gold mining ETF, remain near their three-year low, reinforcing our thinking that North American investor positioning in the precious metals mining space remains relatively lean. On the same note, silver, which has often acted as a high beta cousin to gold bullion, has not attracted much investor attention of late. Total silver bullion ETF holdings have continued to languish over the past 18 months. This serves to inform us that while investors have continued buying bullion as an insurance policy for their portfolios, investors are not currently seeking leverage to their gains from the potential rise in the price of gold, which gold and silver mining equities have typically provided. Similarly, we see relatively neutral levels of participation by investors and speculators in the gold futures market.
Normally, these developments might indicate that we are in for a “normal” year for gold. 2018, however, is not likely to be a normal year in our estimation. With the passage of the Tax Cuts and Jobs Act in the U.S. at the end of 2017, the Republican Party signaled its willingness to dive deeper into debt during a time of economic expansion. The cost of this bill is expected to top $1.5 trillion over the coming decade (see Trey Reik’s commentary: Just Get Tax Reform Done!). On top of this colossal debt burden, there is signaling for further additions to the deficit as the House and Senate try to put together an infrastructure plan which would cost upwards of $1 trillion. The lack of fiscal restraint was well telegraphed by the incoming Trump administration in 2016, at a time when the economy was gaining steam and monetary expansion was firmly in place.
Fast forward a year, and we now have a situation where the U.S. Federal Government’s balance sheet continues to expand, the Federal Reserve remains dovish, the fiscal deficit is set to rise quickly and the U.S. economy continues to hum. Has anyone mentioned inflation yet? We are beginning to see inflation materialize. Energy prices are up, producer prices are on the rise and against all odds, wages are finally beginning to increase. It is no wonder that the combined effect of the factors above are weighing heavily on the U.S. dollar.
Indeed, in our estimation, one of the most significant developments of 2017 was the decline of the U.S. dollar, which lost almost 9.87% (DXY3) of its value when measured against a basket of other major currencies.
Figure 2: The Declining U.S. Dollar
DXY Index Measured Daily
Source: Bloomberg. Data as of 1/26/2018
Figure 3: U.S. Dollar (DXY) vs. Gold (XAU4) (1/2015-1/2018)
Source: Bloomberg. Data as of 1/26/2018.
As you can see from Figure 3, a declining U.S. dollar benefits gold prices. We believe that pressure on the U.S. dollar is likely to continue in 2018 on the back of increasing inflationary pressures, non-existent fiscal restraint and a dovish incoming Fed Chair (Jerome Powell). In January, the U.S. dollar broke below the important 90 threshold, and declined 3.25% (from 92.124 to 89.133 based on the DXY).
When the currency of a nation declines from increasing debt in an environment of easy money policies and artificially low interest rates, the perfect environment is created for gold to thrive. This is what we are facing today, similar to what we saw between January 2003 and December 2006 when gold prices climbed more than 80%, from $350 to $635 per ounce, while the U.S. Dollar Index (DXY) lost 18% of its value. It is no surprise that the rapid appreciation in gold also attracted speculative interest in gold equities, which saw the widely followed HUI Gold Index rise 142% in the same period.
As my colleague Trey Reik explained last month in Sprott Gold Report: 2017 Redux:
|1||SPDR Gold Shares (GLD) is an exchange-traded fund and is used as a benchmark to measure gold bullion prices.|
|2||VanEck Vectors Gold Miners ETF (GDX) tracks the overall performance of companies involved in the gold mining industry.|
|3||The U.S. Dollar Index (USDX, DXY) is an index of the value of the U.S. dollar relative to a basket of foreign currencies.|
|4||XAU is an index of precious metal mining company stocks that are traded on the Philadelphia Stock Exchange.|
This content may not be reproduced in any form, or referred to in any other publication, without acknowledgment that it was produced by Sprott Asset Management LP and a reference to www.sprott.com. The opinions, estimates and projections (“information”) contained within this content are solely those of Sprott Asset Management LP (“SAM LP”) and are subject to change without notice. SAM LP makes every effort to ensure that the information has been derived from sources believed to be reliable and accurate. However, SAM LP assumes no responsibility for any losses or damages, whether direct or indirect, which arise out of the use of this information. SAM LP is not under any obligation to update or keep current the information contained herein. The information should not be regarded by recipients as a substitute for the exercise of their own judgment. Please contact your own personal advisor on your particular circumstances. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any investment funds managed by Sprott Asset Management LP. These views are not to be considered as investment advice nor should they be considered a recommendation to buy or sell. SAM LP and/or its affiliates may collectively beneficially own/control 1% or more of any class of the equity securities of the issuers mentioned in this report. SAM LP and/or its affiliates may hold short position in any class of the equity securities of the issuers mentioned in this report. During the preceding 12 months, SAM LP and/or its affiliates may have received remuneration other than normal course investment advisory or trade execution services from the issuers mentioned in this report.
SAM LP is the investment manager to the Sprott Physical Bullion Trusts (the “Trusts”). Important information about the Trusts, including the investment objectives and strategies, purchase options, applicable management fees, and expenses, is contained in the prospectus. Please read the document carefully before investing. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated. This communication does not constitute an offer to sell or solicitation to purchase securities of the Trusts.
The risks associated with investing in a Trust depend on the securities and assets in which the Trust invests, based upon the Trust’s particular objectives. There is no assurance that any Trust will achieve its investment objective, and its net asset value, yield and investment return will fluctuate from time to time with market conditions. There is no guarantee that the full amount of your original investment in a Trust will be returned to you. The Trusts are not insured by the Canada Deposit Insurance Corporation or any other government deposit insurer. Please read a Trust’s prospectus before investing.
The information contained herein does not constitute an offer or solicitation to anyone in the United States or in any other jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation. Prospective investors who are not resident in Canada or the United States should contact their financial advisor to determine whether securities of the Funds may be lawfully sold in their jurisdiction.
The information provided is general in nature and is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering or tax, legal, accounting or professional advice. Readers should consult with their own accountants and/or lawyers for advice on the specific circumstances before taking any action.
You are now leaving Sprott.com and entering a linked website. Sprott has partnered with ALPS in offering Sprott ETFs. For fact sheets, marketing materials, prospectuses, performance, expense information and other details about the ETFs, you will be directed to the ALPS/Sprott website at SprottETFs.com.Continue to Sprott Exchange Traded Funds
You are now leaving Sprott.com and entering a linked website. Sprott Asset Management is a sub-advisor for several mutual funds on behalf of Ninepoint Partners. For details on these funds, you will be directed to the Ninepoint Partners website at ninepoint.com.Continue to Ninepoint Partners