Dollar Weakness Helps Gold To All-Time Highs

Image by Linda Hamilton from Pixabay

By JOE FOSTER/VanEck

Market Review

The gold bull market passed two important sign-posts in July. The strength of the market is impressive as it blew through $1,800 and the all-time high of $1,921. These prices had been major technical resistance points set a decade ago.

The second significant signpost in July was the new U.S. dollar weakness. U.S. dollar weakness is a hallmark of most gold bull markets, but in this cycle gold had so far been rising in a flat dollar environment. The chart below shows the U.S. dollar index (DXY) has been in a bull market since 2011. However, the dollar declined through July, then fell precipitously at the end of the month, appearing to have broken its long-term trend. We may be seeing the beginnings of a bear market for the dollar. This enabled gold to test the $2,000 per ounce milestone as it reached an intraday high of $1,983 on July 31. Gold closed out July at $1,975.86 per ounce for a $194.90 (10.9%) monthly gain.

U.S. Dollar Index Breaking Its Near 10-Year Support Trend? (2011 - 2020)

Click chart to enlarge.

Gold stocks moved higher as the vast majority of companies reporting second quarter results met or exceeded expectations. COVID-related costs were also reported, showing the industry has done an excellent job of dealing with operational issues in our view. For example, 1.7 million ounce producer Agnico-Eagle was among those hardest hit by pandemic lock downs. Its costs for temporary mine suspensions totaled $22 million, whereas the cash provided from operations totaled $162 million. Going forward, per the company’s second quarter 2020 financial results, Agnico-Eagle expects COVID protocols to cost $6 per ounce, which raises their cash costs by less than 1%.

Junior developers are a class of company that you won’t find much of in passive index funds like GDX or GDXJ. These are companies with properties that are in various stages of development, but not yet producing gold. Our active gold equity strategy invests across the spectrum of companies and currently carries 22 junior developers that total approximately 26% of the strategy’s net assets as of end-July. These companies had been underperforming since the gold price broke out in June 2019. This is a sharp contrast from past bull markets, when the juniors began outperforming the larger companies much earlier. Through the second quarter and into July, the junior developers have finally kicked into gear. Seven of our juniors have now gained over 100% year to date. We don’t expect to give back these gains because the stocks had been extremely undervalued and many of our companies have announced encouraging drill results and new discoveries that create lasting value. In addition, investors have returned to the junior sector, enabling companies to raise $1.5 billion this year, and the second quarter was their strongest for equity raises since 2012, according to RBC Capital Markets.

Outlook

Gold has tested the $2,000 per ounce level sooner than we had anticipated and we believe there is more than the pandemic to overcome at this point.

• Slower Recovery – During July, two Federal Reserve (Fed) presidents, a Fed governor, and its Chairman all warned of a long, slow road to economic recovery. Initial jobless claims have stagnated for eight weeks at around 1.4 to 1.5 million. Contrast this with the Global Financial Crisis (GFC), where initial jobless claims declined steadily to 587,000 in the same time frame, seventeen weeks after the recession peak. JPMorgan said it was preparing for an unemployment rate that remains in double digits well into next year and a slower recovery in gross domestic product (GDP) than the bank’s economists assumed three months ago.
• Deficits, Debt & Defaults – The U.S. budget deficit totaled $863 billion in June, as much as the entire gap in 2019. With the new stimulus bill now being considered in Congress, the annual deficit could exceed $4.7 trillion. This is on top of record peace-time deficits before the pandemic. Corporate debt is also at record levels and many households are feeling financial stress. Ultra low interest rates over the past two decades have encouraged the accumulation of unproductive government and private debt. It fuels the rise of giant firms, while “zombie” companies (companies with earnings less than their debt service costs) have proliferated. This is at the expense of start-ups, innovation and creative destruction. The result is low levels of productivity, causing recoveries to become weaker and weaker. The Wall Street Journal reports the largest U.S. banks have set aside $28 billion to cover losses as consumers and businesses start to default on their loans.

The pandemic created a deflationary shock to the economy and the massive accumulation of debt since the GFC creates a drag on productivity that could guarantee a low growth economy for decades to come. Negative real rates, persistent risks to economic well-being, and the weak dollar are drivers that we believe could enable gold to trend to $3,400 per ounce in the coming years. This might be a conservative forecast considering the 180% rise gold experienced from the depths of the GFC. Several scenarios could see gold prices moving higher from there:

• Systemic collapse as debt issuance overwhelms the financial markets.
• An inflationary cycle brought on by either: a) trillions of U.S. dollars, euros, yen and yuan being pumped into the global financial system, b) governments enabling inflation to ease the debt burden, c) implementation of modern monetary theory or other forms of money printing to fund government spending without issuing debt.
• U.S. Dollar Crisis – America is dealing with deficits, divisive politics, social unrest and deteriorating international relations on a scale rarely seen in history. While other countries may have similar problems, they do not oversee the world’s reserve currency. The U.S. is held to a higher standard and a crisis of confidence could weigh heavily on the dollar.

Some might balk at such bold forecasts, however, we believe the various drivers of gold are rarely aligned as they are today. We also consider gold’s relative size in the financial markets. There have been 200,000 tonnes of gold mined in the history of the world and virtually all of it is potentially available to the market. A gold price of $2,000 per ounce yields a market value of $12.9 trillion. Compare this with global stock, bond and currency markets, each of which totals roughly $100 trillion or more. A relatively small shift in funds from these markets may fuel the gold price for a long time.

In addition, the market value of the global gold industry as of end-July is approximately $530 billion. The market value of Alphabet Inc. as of the same time, alone, is $1.0 trillion. Gold mining is a relatively tiny sector that, in addition to carrying earnings leverage to the gold price, carries a scarcity factor when market demand is high.

VanEck Securities Corp. is an Associate Member of TEXPERS. The views expressed in this article are those of the authors and not necessarily VanEck nor TEXPERS.

About the Author

Joseph Foster joined VanEck in 1996 as a precious metals mining analyst, and has been Portfolio Manager for the VanEck Gold Strategy since 1998. He also serves as Strategist for the VanEck Global Hard Assets Strategy. He covers gold mining equities ranging from small-cap exploration to senior producers. He also forecasts and monitors gold-related market conditions and models the asset bases of mining companies.

Foster is one of the most experienced investment managers in the field of gold and gold stocks portfolio management, with over 35 years of experience in the industry as a geologist and investment manager. He has over 14 years of dedicated experience in geology and mining. From 1992 to 1996, he was a Senior Geologist at Pinson Mining Company, where he managed an on-site geology department and conceived and implemented a comprehensive exploration program on a 35 square-mile land position. His primary responsibility was to find new gold reserves that could extend the life of the mine. In addition, Mr. Foster established an AutoCAD-based geologic information system that incorporated geological, geo-chemical, geophysical, topographic, and drilling data compiled over a 20-year period. From 1988 to 1992, as a Mine Exploration Geologist, Foster planned and supervised up to 30,000 feet of exploration drilling per year. Prior to 1988, he was an Exploration Geologist with Lacana Gold Inc. in Reno, Nevada. Foster started his career in 1981 as a summer intern as a geologist for Atlas Mining, an underground uranium mine in Green River, Utah.

Foster received a master's degree in Geology from the Mackey School of Mines and an MBA from the University of Nevada-Reno. He graduated Magna Cum Laude with a bachelor's degree in Geology from Tennessee Technological University. Foster has appeared in The Wall Street Journal, Financial Times, Barron’s, The Wall Street Reporter, Reuters TV, CNBC, Fox News and Bloomberg TV. He has published articles in mining journals, including Mining Engineering, Society of Economic Geology, and Geological Society of Nevada.

On the Horizon: Preparing for a Weaker Dollar Era

Image by Thomas Breher from Pixabay 

By ROBERT M. DALY/Glenmede

Profound shifts in the macro economic, competitive and political environment are converging to create a potentially long-lasting period of weakness for the world’s reserve currency. While many analysts and investors have been debating the potential for a short-term crash of the U.S. dollar (USD), in our view investors should be considering how to prepare for the possibility of a long-term period of dollar weakness.

Recent Depreciation Highlights that Issues are Likely to Linger

After bouncing back from an early March low caused by COVID-19 concerns, the U.S. Dollar Index (DXY) has resumed its slide, dipping approximately ten percent from its mid-March peak and moving toward two-year lows. An analysis of the drivers for this decline shows a multitude of reasons for this trend, including macro conditions, monetary and fiscal policy, trading fundamentals and a structural shift in how the dollar works within the global investment framework. When examining the major U.S. dollar pairs[1], we see four key issues behind the shift in the dollar’s valuation:

Source: Bloomberg. Click chart to enlarge.

1. The 2008 Dollar Shortage no Longer Exists

A myriad of issues makes it hard to argue that the U.S. dollar shortage continues to be an issue, as detailed in a recent GaveKal research report (GaveKal Research: “The US Dollar Starts to Break Down” July 22, 2020). In 2008, the U.S. dollar was the world’s overarching currency, and the United States was one of the only major economies with positive interest rates. During that time, the U.S. current account deficit was between 4-6 percent of gross domestic product. Plus, foreign-domiciled U.S. dollar debt was a legitimate concern during the great recession. In contrast, today interest rates are hovering near the zero lower bound, the current account deficit is widening, and U.S. money supply (M2) is growing at 24.5 percent per year. Additionally, the U.S. Federal Reserve has also opened up swap lines with 14 other central banks. GaveKal Research: “The US Dollar Starts to Break Down” July 22, 2020).

Source: Bloomberg, Bank of Canada, Bank of England and European Central Bank. Click chart to enlarge. 

2. Competition Across the Globe 

A credible alternative to the U.S. dollar may be emerging as the European Union appears to be regaining strength, making it attractive to investors again. In a demonstration of solidarity that Alexander Hamilton would envy, EU members’ decision to jointly issue up to 750 billion euros for the EU’s historic stimulus plan signals reassuring unity for the euro. However, the real question will be whether the European experiment provides a lasting stable fiscal foundation. Overall, we believe the EU developments can change how reserve managers and asset allocators think about their options around the world.

Source: Bloomberg. Click chart to enlarge.

3. Interest Rate Divergence Between China and the United States

China is not monetizing the COVID-19 crisis, while the United States pursues a policy of debt monetization. This difference in monetary policy has the potential to create a stark divergence in long-term interest rates between the countries.

4. The Unpredictable U.S. Political Backdrop

A chaotic U.S. political environment is making a very uncertain construct for the dollar. A divided government, a seeming inability to effectively address the COVID-19 pandemic, tax implications from the stimulus packages, election-year political dynamics and heightened Sino-U.S. tensions are just some of the concerns complicating monetary policy.

In short, we are now in a period of ample liquidity provisioned by the major world’s central banks combined with an uncertain U.S. domestic situation. The investment environment has changed markedly and in ways that are likely to continue for quite some time. 

Broader Implications for Investors

Given these significant and potentially long-term shifts, investors have a number of potential considerations as they map their asset allocation and investing strategies:

1. Inflation Dynamics

The decline in real interest rates against nominal rates completely bounded by the U.S. Federal Reserve has caused U.S. breakevens to rise significantly. While this would suggest a deflationary environment, there is real concern that persistent debt build up coupled with a depreciation in the dollar could create a higher likelihood of inflation as we move into 2021. According to Goldman Sachs (Gold Views: In search of a new reserve currency), the United States’ expanded balance sheet and vast money creation could heighten fears about the value of the dollar. The outcome likely would then be higher inflation but at a surmountable level. We are do not currently projecting anything similar to a 1970s scenario.

2. Gold and Metals

Gold can be a very good hedge in portfolios specifically against inflation. We believe that with real interest rates at all-time lows, an appropriate allocation to gold, as well as other metals such as silver, could make sense for investors.

3. Emerging Markets

A weaker dollar is good for external global growth. We believe that the current dollar dynamic may be a predictor of better returns in emerging markets.

Thinking More Broadly for the Longer Term

The current dynamics may lead to a very different investment environment than we have seen recently. Monetary trends today are supportive to treasury inflation-protected securities, metals such as gold and silver, and emerging markets. Going forward, investors may need to consider a more global construct, looking well beyond the U.S. domestic focus that has dominated the past decade.

While we think about the dollar’s decline and the inflationary scenario that the market is worried about, we don’t perceive these as fundamentally problematic at this time. Real interest rates are the narrative. The driver pushing risk assets is the continued low interest real rate environment. As real interest rates continue to drop, and the dollar declines, risk assets persist as attractive opportunities.

Source: Bloomberg. Click chart to enlarge.

Glenmede Investment Management, LP, is an Associate Member of TEXPERS.The views expressed in this article are those of the author and not necessarily Glenmede Investment Management nor TEXPERS.

Sources:

[1] The major pairs are the four most heavily traded currency pairs in the forex market. The four major pairs are the EUR/USD, USD/JPY, GBP/USD, USD/CHF.

About the Author: 

Robert Daly is Director of Fixed Income for The Glenmede Trust Company, N.A. and Glenmede Investment Management LP. He is responsible for the management of over $4 billion of tax-exempt and taxable fixed income strategies for institutions, consultants and private clients. Daly works closely with a team of traders, portfolio managers, credit analysts and other professionals to broaden exposure to GIM’s fixed income suite. He also serves as a member of GTC’s Investment Policy Committee. 

Prior to joining Glenmede, Daly served as a Senior Portfolio Manager for U.S. and global fixed income strategies at BlackRock in New York. In this role, he was instrumental in establishing and managing a team responsible for asset allocation development, portfolio construction, risk budgeting and formulating investment process. Previously, Daly managed multi- sector and investment grade credit fixed income portfolios for institutional clients. 

Daly earned a Master of Business Administration degree in finance and accounting from Columbia University and his Bachelor of Arts degree in government from Dartmouth College.