Why “gold-diggers” could be 2019’s biggest winners

I don’t usually send you an issue on a Saturday, but I wanted to complete our three-part gold series with Eoin before our special event next week.

So today, I have the third and final part of our how to understand and invest in the gold market series. It’s called why “gold-diggers” could be 2019’s biggest winners. And you can find it below.

If you missed parts one and two you can find them here and here.

And if you’d like to get in on Eoin’s number one gold play, which he believes could make you as much as ten times your money, follow this link now.

Now I’ll hand you over to Eoin…


The unseen danger

It has already been an eventful year, hasn’t it?

The evolving Brexit drama continues to dominate headlines. The yellow vests in France are getting politically organised. China and the US are edging ever closer to at least an interim deal.

US President Donald Trump and North Korean leader Kim Jong Un have just agreed to another meeting. The European Central Bank has just announced the end of its quantitative easing programme but just can’t seem to stop buying bonds. China’s economy is slowing. And Venezuela is on the cusp of total disintegration.

No one can be sure how any of those events will finally unravel.

But there is one thing that is definitely going to happen in 2019 that is just not making headlines right now:

The US Government has to issue approximately $600 billion in bonds to cover the deficit that has been created by the tax giveaway President Trump pushed through soon after taking office.

At the same time the Federal Reserve, the US’s central bank, expects to reduce the size of its balance. If it were to continue on the assumed path, it would represent a total of $1.2 trillion in additional bonds that need to find a home in 2019.

Someone has to buy those bonds or the US (and the world) is in trouble.

On top of that, investment grade corporations have about $595 billion in bonds that mature in 2019.

The vast majority of companies never pay back their debt. They usually roll it over by issuing new bonds so that represents a significant block of new bonds the market needs to swallow in 2019. And interest rates are 2.25% higher today than at any point between late 2008 and late 2015, when hundreds of billions in bonds were issued.

See the problem here?

What we have in front of us is an impending case of investor indigestion. It’s an awfully big question where the appetite for all those bonds is going to come from.

In fact, the market conditions over last few months have seen the exact opposite of what a logical investor would expect when faced with the certainty of massive bond issuance.

Bond prices rallied impressively as the stockmarket sold off between October and late December. In the short term, safe haven demand simply overrode the dire outlook for the bond market this year.

With stockmarkets now having steadied up, bonds are still steady suggesting investors are willing to bet that interest rates are not going to rise again in this cycle.

The simple fact of the matter is a lot of people got out of stocks at the end of last year and they are still gun shy even after the rally that has taken place. They are going to need to some time to be, re-convinced of the bullish argument and that has created demand for bonds.

One of the biggest lessons I have learned from my study of bull markets over the last 20 years is they don’t tend to end because demand dries up. They end because supply increases so much it overwhelms demand.

The great bond glut of 2019

Think about that for a moment.

The tech bubble ended for lots of reasons but one of the big ones that affects stock prices was the massive number of initial public offerings (IPOs) that hit the market in the late 1990s.

The commodity bull market ended in 2008 for lots of reasons but one of the main ones was lots of mines opened up at the same time, supply surged and overwhelmed demand.

The same thing happened in oil. The advent of hydraulic fracturing and horizontal drilling introduced a massive new source of new supply to what had previously been a tight market. That resulted in prices falling precipitously.

You get the picture.

When supply increases, a lot, it puts pressure on prices. In the bond markets when prices go down, that means yields go up. When yields rise that means everyone pays more to borrow money.

When governments have to pay more to borrow money and they are running record deficits the pressure that builds on the economy is released in lots of different ways. But the most important one for investors is the currency gets weaker.

That is a perfect condition for gold and gold stocks to flourish in.

Right now, the US dollar is still pretty steady so this is not going to sound like an imminent danger. However, markets can turn fast.

And it has become an increasingly popular view among institutional investors that the dollar is going to decline this year in a meaningful way.

If you think about it another way… The simple fact of the matter is governments’ answer to every problem is, “Here, have some money.”

When the teachers strike, they get pay rises. When the police complain, they get pay rises. When the truck drivers strike, they get pay rises. When the people complain about living standards, taxes are cut and social services are boosted.

All of this is paid for with debt and the rise of populism means governments are going to be running big deficits for the foreseeable future.

It’s a lot easier to print money than it is to tackle the fundamental problems with a debt-addicted society. The rise of populism means people are voting for more money to be spent. That is going to mean more bonds and more currency will be printed to pay for them. If there is more money sloshing around it means the pounds in your pocket are worth less.

Golden horizons

What do you do when you need a store of value against the worst inclinations of politicians to inflate their problems away, robbing savers in the process? You buy gold.

Gold is in short supply, gold cannot be printed into existence and it is beholden to no one. Gold is the everyday person’s insurance against the worst excesses of government. Little wonder then that it is rising.

There are two other reasons that are worth considering for why the US dollar in particular should decline.

The first are the actions of the Federal Reserve.

By signalling that the pace of balance sheet reduction is debatable, the Federal Reserve has sent a message to markets clearly signalling they are sensitive to the volatility in markets.

The reduction of the balance sheet was one of the primary arguments for why the dollar was so steady over the last year. By reducing the number of dollars in existence, the supply was decreasing – which effectively made the dollars in circulation more valuable.

That’s argument is no longer as valid as it was at the beginning of the year because the balance sheet reduction is now questionable.

The dollar is the world’s reserve currency, and if one of its major supports has just been removed, that’s important for all assets but most especially gold because of its long history as a store of value.

The second big reason is the evolving acceptance of Modern Monetary Theory.

The basic premise of this growing academic field is budget limits are self-imposed political targets. But a country could in theory print as much money as it needed to fund infrastructure and other programmes provided it has the ability to issue sovereign debt in its own currency.

I know what you’re thinking. That doesn’t make sense. If a country were to just print currency willy-nilly it would stoke an inflationary spiral. That is why the proponents of Modern Monetary Theory believe the only true limit on government spending should be inflation. In the absence of inflation there is no limit on how big a deficit a country can run.

That is theoretically true, but what it would do is rubbish the argument the dollar is a store of value. And once belief in the dollar collapses – run for cover.

The reason I bring this up is because Modern Monetary Theory and the belief “deficits don’t matter” is a topic that is on the fringe right now but is attracting adherents all the time.

It is virtual certainty that at least one candidate, and possibly President Trump himself, are going to adopt Modern Monetary Theory as their economic platform heading into the 2020 election.

Why wouldn’t they make these impossible promises? People are angry. Living standards have been static for what feels like forever. The clarion call of the disenfranchised is “What about me?” and politicians’ primary proclivity is to write a cheque.

Margaret Thatcher astutely pointed out that “The trouble with Socialism is that eventually you run out of other people’s money.” Today that desire to spend is not limited to socialists. Faced with populism and a lurch to the fringes of the political spectrum, whatever party is in power will get in on a spending programme.

Anyone with any sense could see that the ultimate end of the debt buildup that has taken place over the last 40 years was inflation. It is the only way, short of default, that any of the G7 nations are going to meet their obligations, let alone fund healthcare and retirement commitments.

That is going to put significant downward pressure on the dollar, but politicians the world over are likely to glom on to the idea of funding infrastructure and social programs with printed money. As soon as one country adopts a direct ploy to devalue its currency, everyone else will as well.

That is about as bullish an argument for owning gold as one might wish for and it is why I have launched gold stock fortunes and am getting ready to profit from a gold bull

If you’d like to join me, you can find out more here.

And it’s not just the US that could catalyse a big gold price move in the near future…

The China Trigger

China is going to do whatever it can to protect themselves and its interests.

We are seeing Asian countries, including China, stockpiling physical gold. It sees a time coming when having hold-in-your-hand gold will be incredibly important when it comes to preserving wealth.

Nationalism is rising there too and China is building aircraft carries as well as a daisy chain of military bases between itself and the Persian Gulf under the guise of the Belt and Road programme. Make no mistake, we haven’t even seen the beginning of geopolitical uncertainty and historically that has been favourable for gold.

Taking in all of the above, we are looking at a rare and exciting time to start investing in gold. In this scenario, $10k gold is not out of the question. If everything falls into place… I would not be surprised to see that price at all.

So, the question is: how do we maximise this expected gold boom?

Digging for gold

Let’s look at the beginning of the last big run in gold in the early 2000s for some guidance…

Gold prices had been falling for what felt like forever and when Gordon Brown eventually threw in the towel and sold the UK’s gold at the low, the market saw that the last big seller had sold so all that were left were potential buyers.

The mining industry had been savaged by decades of declining prices. When times are bad, miners stick to tried and true survival techniques. They only mine the very best grades they have because that keeps costs down. Every time there is an uptick in the price, they move on to less profitable veins so they can save the really profitable bits for when prices fall again.

They had been following that strategy for decades since the collapse from the 1980 peak with the result that the really good veins were long exhausted. That meant gold mining was a really marginal business because they were just about getting by at prevailing price.

The people that survive long bear markets are inherently conservative. They don’t go out and take big risks, they abhor debt and are incredibly cost conscious. If you don’t have those characteristics, you don’t survive a bear market.

When the price of gold started to rally the miners were initially very cautious about investing in new supply because they had been disappointed so often before. That mean the shares were highly leveraged to the gold price and they took off like rockets.

It took about five years before gold miners had the courage, not to mention the track record, to source funding for expansion again.

2019: green light for gold mining boom

The good news from an investment perspective is we have a very similar set of circumstances evolving today. Global liquidity is tight so all high-risk ventures are having a harder time sourcing funding. The Chinese economy is slowing down so commodity prices are beaten up and no one wants to lend to miners.

In fact, Standard Chartered got into a lot of hot water by being overly generous to miners before prices went south so other banks are now a lot more reticent.

The price of gold has been going basically nowhere for three years, after a short sharp pop on the upside in early 2016, so investors do not feel a sense of urgency. I have a list of miners that are nicely profitable as long as prices hold above $850.

The price at the time of writing is $1,330. The reason these companies are not doing better is because there is no belief in the investment community that gold is going to move higher from here. Because miners are not investing in new supply, they are essentially in command of a wasting asset.

This puts miners in a very favourable position when prices start to rise meaningfully again. They are in command of the only source of additional supply and as long as debt loads are kept under control, they can start to pay significant dividends.

Today, many gold miners report the all-in cost of production. That is a reporting condition that was forced upon them by shareholders during the price collapse in order to give investors visibility on their production costs and to ensure their spending was under control.

Gold miners are running much tighter ships today and have returned to their conservative spending policies.

Recently, we have seen two significant mergers in the gold mining sector. First, Barrick Gold acquired UK-listed Randgold Resources in an all-stock offer. Then Newmont Mining acquired Goldcorp in a cash and stock offer to take the total merger and acquisition (M&A) value to $15 billion in two weeks.

Why would gold miners buy other miners rather than spend the money on a new mine?

The answer is simple enough. Acquisitions at today’s levels are a bargain and when you buy an established mine, you know they have the resource.

Building new mines and proofing up reserves is an inherently uncertain proposition and the number of new truly high-grade mines being found is frighteningly small.

This process of consolidation at low prices is exactly what any rational investor would do. After all, the key to investing is buying low so you can sell high. Too often over the last decade we have seen miners and energy companies pay sky-high prices for assets only to see prices collapse subsequently.

Personally, I am a much bigger fan of buying after a major pullback than after a big advance.

The pace of M&A activity also tells us that the miners themselves are positioning for higher prices. In my view, smart investors should be doing the same: looking at loading up on physical gold and making strategic investments into undervalued gold miners.

And in terms of those, I can’t wait to show you what I have found. Right now there are two companies that I think could see huge upside in the coming months and years.

You can find out all about them here.

Through these two investments a ten-fold return on your money is a real possibility, in my view. But, of course, timing is everything!

So if you’re interested, and want to take advantage, I’d advise you to follow that link now.

Until next time,

Eoin Treacy
Southbank Investment Research

Category: Commodities

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