Eric Sprott Analyzes Trump’s Trade War With Mexico (and likely China Next):
“It’s scary to be honest…You could see Russia, China, even the EU stop buying US bonds… ”
How Will This Affect Gold and Silver? - Source
During the past three months, market sentiment has shifted on fundamentals dominating short-term trading in gold markets. Consensus views have gravitated towards further Fed tightening, rising Treasury yields and a strengthening U.S. dollar. In the body of this report, we have outlined our reasoning as to why each of these assumptions may be short-sighted.
In our view, cumulative and immutable imbalances (debt levels, valuations, dollar liquidity) will soon test recent sentiment shifts, we expect decidedly in gold’s favor. While we are not stocking canned goods, oiling muskets, or bottling water, we are suggesting that a modest portfolio allocation to gold has never been more prudent.
A consistent theme at investment conferences during 2016 has been the compression of investment returns. Especially in the pension and endowment world, very few institutions are achieving chartered rates of return. While institutions might have expected historically to achieve real rates of return of 5% on equities and 2 ½% on bonds, the realities of achieved returns during the past several years are tracking (at the high end) roughly half these historical levels.
We believe the root cause for compressed returns is far simpler than much of the sophisticated quantitative analysis we have encountered. The United States has a structural debt problem, and the Fed has employed ZIRP for eight years to forestall rationalization of this untenable debt load. As every student of economics is aware, marginal returns gravitate towards marginal costs.
The longer the U.S. economy operates in a ZIRP environment, the closer to zero will migrate the sum-profit-total of U.S. economic agents. Recognizing this, the Fed has telegraphed for years a desire to normalize rate structures. Consensus has recognized the Fed’s poor track record in achieving rate normalization but, in our view, has failed to grasp the true impediment to higher rates.
It is not popular to suggest U.S. debt levels cannot sustain higher rates, but we believe these are the root facts. During the past decade, global productivity has collapsed to its lowest level in the modern financial era. Optimists shrug off these statistics as outdated and unreflective of vast productivity enhancements enabled by the internet, I-Phones and social media. We cite this example (which we will develop further in our February report) as a metaphor for a broader condition in global asset markets.
Most investors sense that there are looming risks in financial markets and troubling impediments to healthy global growth. Yet, the relentless performance of the S&P 500 Index has reinforced the inclination to ignore these nagging concerns. In the institutional arena, excessive bearishness or even adoption of defensive and hedged strategies can handicap performance and introduce career risk. To us, an allocation to gold is a powerful tool to help insulate portfolios from potential dislocations in a complicated financial world. In essence, a gold allocation can provide a bit of cheap insurance to any ongoing investment program.
We continue to marvel at gold’s lack of sponsorship in the institutional arena. During the past hundred years, even a modest portfolio commitment to gold has been proven to push total portfolio returns further to the right along return frontiers for any reasonable asset mix, generating equal returns with less risk and standard deviation, or superior returns with equivalent risk and standard deviation, versus identical portfolios without a gold investment component (World Gold Council).
During the past 16 years, gold’s non-correlated and market-leading returns have provided invaluable portfolio alpha in an increasingly challenging investment environment. During the next several years, mounting monetary, economic and financial imbalances, which appear to be approaching important tipping points, suggest gold is a portfolio-diversifying asset worthy of serious consideration.
We view corrections in gold markets during the fourth quarter of 2016 as fairly standard retests of early 2016 breakouts from established downtrends. To us, underlying fundamentals suggest significantly higher gold prices during the next several years.
Gold’s Prospects in 2017 and Beyond
Over the long run, we believe the gold investment thesis rests squarely on monetary, economic and financial imbalances which continue to be resolved to the measurable benefit of investors choosing to denominate a portion of their wealth in assets which can neither default nor be debased. Over the short run (one-to-two years), gold’s performance can be impacted by consensus views on a wide array of market variables.
We would highlight five such variables as motivating the lion’s share of trading patterns in gold markets: Fed policy, the U.S. dollar, 10-year Treasury yields, U.S. economic performance and U.S. equity risk premiums. It is unusual for any single event to impart significant impact on all five of these variables simultaneously. The Trump election has certainly proven to be such an event!
Trump’s victory has unleashed one of the strongest expressions of business and financial optimism in history, starkly affecting variables central to gold’s short-term trading patterns. While optimism is never a bad thing, we suspect financial markets are reflecting classic emotional blow-off.
Investors, admittedly parched for a more normalized economic world unfettered by QE and ZIRP, have, in our view, temporarily lost sight of immutable realities such as debt, valuation, debasement and mathematics.
Should our suspicions bear out that reigning euphoria proves short-lived, recent market dislocations will provide excellent entry points for a wide array of investment assets. Given our confidence in underlying fundamentals relevant to precious-metals, we view the Q4 back-up in gold markets as a rare opportunity to achieve a significantly discounted entry point in gold’s unfolding advance.
Despite being in a multi-year bull market for oil, herd mentality has taken over as fears around a potential Border Adjustment Tax by the Trump administration have led to the pummelling of Canadian oil stocks with many falling by 15 per cent+ this month. We do not believe the U.S. president will push through a BAT that includes oil, as it would increase the average household’s gasoline expense by $300-$400/year and would be highly politically unpopular and counterproductive to his re-industrializing of the American economy. As such, we view the risk-reward as extremely favourable for aggressive capital deployment. We are “all in” and believe we own stocks that have the potential to appreciate by over 60 per cent over the next 18 months. This month reminds us of January 2016 when people were panicking, stocks were imploding, and our will was tested from being fully invested. How did it turn out? The Sprott Energy Fund rallied by over 140 per cent from the lows seen in that month. Now is not the time for panic; it is the time for disciplined investment and a
We believe a very large U.S. seller has been responsible for the stock falling by 16 per cent this month and is the poster child for what has happened to Canadian oil stocks due to worries around the Border Adjustment Tax. The stock now trades at 4.9X 2018 EV/CF on our commodity assumptions versus formerly trading at 8.0X. We see over 65 per cent upside in the stock over the next 18 months. SPE is a very low-risk way to play our multi-year bullish view on oil.
Birchcliff Energy is at the beginning of a multi-year internally-funded ramp in production as it grows its core Montney production and explores a new liquids-rich zone. The company has never been in a better position to create long-term shareholder value given a much improved balance sheet, strengthened inventory, and exploration upside. The stock trades at 5.3X 2018 EV/CF at $3/mcf gas and we have an 18-month $13.30 target which equals over 60 per cent upside.
Trican Well Services is benefitting from the beginning of the inflection in pressure-pumping pricing. Prices are up 20 per cent from the bottom and we believe could go up another 30 per cent to 40 per cent by year-end. They also monetized a portion of their interest in a U.S. pressure pumper called Keane which the street is mispricing. Giving a mark-to-market valuation on Keane, which we believe is worth $2.10/share, TCW is trading at 4.3X 2018 EV/EBITDA when a mid-cycle valuation is 7.5X. This would imply upside of over 50 per cent.it of patience. The Sprott Energy Fund is the #1 Energy Fund in the country on a one- and three-year basis as of December 30, 2016.
Kirkland Lake Gold (KLG.TO) has agreed to join forces with Newmarket Gold (NMI.TO) in an all-stock deal worth about $1 billion.
Retail and institutional investors are likely to take a shine to both the deal and the new gold company, according to Andrew McCreath, BNN Markets Commentator and founder of Forge First Asset Management.
“This is a deal that is trying to make a stock more interesting to more shareholders … and also to lower the cost of production of the combined entity with a higher production base,” he said on Thursday.
Kirkland Lake Gold shares will be exchanged at a ratio of 2.1053 Newmarket shares per Kirkland share, the companies announced in a press release. Once the deal closes, Newmarket shareholders will receive 0.475 shares of the combined company for each share held. Kirkland’s shareholders will emerge with 57% ownership of the merged company. The transaction is expected to close in the fourth quarter of this year, pending approvals.
Newmarket Gold has been on an aggressive expansion spree with the help of Eric Sprott – the noted gold bug. Sprott holds more than nine per cent of Newmarket’s shares and is also the chairman of Kirkland Lake Gold. “Clearly, Eric Sprott is driving the bus on making this transaction work,” said McCreath.
Newmarket CEO Douglas Forster has been trying to build the company into a mid-tier gold producer for the past year. Shares of Newmarket are up more than 250 per cent over the past year – that surge will likely dissuade another company from trying to make a competing bid for the company, according to McCreath, who thinks the popularity of the stock will likely make the deal appealing for traders. “I think this will be a nice little feast day for the merger arb funds out there that like these kind of deals.”
The higher production and lower cost profile will also make the deal appealing to a broader share of gold investors, added McCreath, whose Forge First doesn’t hold shares in either of the merging companies.
The new company will have total gold production of about 500,000 ounces per year from Kirkland’s flagship Macassa Mine in Northern Ontario as well as the Holt, Holloway and Taylor gold mines – all in northeastern Ontario. Newmarket currently operates three gold mines in Australia.
“Macassa is not exactly an easy mine,” McCreath pointed out. “There’s probably not a lot of upside unless gold goes way the heck up from here.”
Gold bug Eric Sprott’s increased stake in Newmarket Gold Inc. has renewed interest in the junior producer, which operates three mines in Australia. Investors are now looking for the Vancouver-based miner to fulfill its promise to boost production while controlling expenses and not overpaying for acquisitions, as the price of gold sits stubbornly at about $1,200 (U.S.) an ounce.
Shares of Newmarket, which merged with Crocodile Gold Corp. in July, have risen by about 13 per cent since the company said on Monday that Mr. Sprott bought 10 million shares to boost his ownership stake to 8.7 per cent. He purchased the stock from Luxor Capital Partners LP, which is still Newmarket’s largest shareholder, now with a 28.7-per-cent stake.
All 10 analysts who cover Newmarket have a “buy” recommendation. The analyst consensus price target over the next year is $3.03 (Canadian), which is about 23 per cent above its current price of $2.46. The stock is up about 82 per cent so far this year.
“As far as junior producers go right now, this is our favourite in the gold space,” said Raymond James analyst Chris Thompson, who has a $3.30 target on the stock, calling the valuation “cheap” compared with its peers in the junior mining space.
Mr. Thompson said the increased investment from legendary investor Mr. Sprott “provides a vote of confidence” in the company’s management and future valuation.
Newmarket’s board includes well-known executives such as mining financier Lukas Lundin and Randall Oliphant, the executive chairman of New Gold Inc. and chairman of the World Gold Council.
“We consider this ‘new kid on the block’ to be underowned by traditional institutional resource fund managers, and to have above-average potential to qualify for addition to several precious metal indices over the next 12 months,” Beacon Securities analyst Michael Curran said in a note. His target is $3.25.
Last month, Newmarket reported an increase in reserves and resources at its flagship Fosterville mine, which could extend its production life.
BMO Nesbitt Burns analyst Brian Quast increased his target on Newmarket to $3 from $2.75 as a result.
The company has no debt and is benefiting from the weak Australian dollar, when compared with the U.S. currency. Gold is priced in U.S. dollars, which means the company receives more Australian dollars per ounce of gold sold. Operating costs are also paid in Australian dollars, which helps to increase margins.
Risks for the stock include a strengthening Australian dollar, the high cost of production in Australia, as well as the potential of overpaying for acquisitions, which has been an issue for gold producers in recent years after the price of gold plummeted from its record above $1,900 (U.S.) in 2011.
“It’s always a little risky and generally M&A activity is not looked upon favourably unless it’s an absolute slam dunk, and there are few of those around at the moment,” Mr. Thompson said.
Newmarket chief executive officer Douglas Forster said the company is on the hunt for acquisitions in Australia and North America, to help reach its goal of becoming a mid-tier gold miner producing 400,000 to 500,000 ounces a year, up from expected production of 205,000 to 220,000 ounces in 2016.
“We do see opportunity, that’s the good news, but we’re cautious,” said Mr. Forster, noting that management and insiders together own about 8 per cent of the company.
He wouldn’t comment on whether there has been any interest in a takeover of Newmarket, but said a hostile bid would be difficult to pull off, given that nearly half of the shares are owned by management, Mr. Sprott and Luxor.
“We’ll do whatever makes sense and that maximizes shareholder value,” Mr. Forster said. “Hopefully, that means we are growing by acquisition and organically. If it means someone else is [interested in acquiring us and achieving] our goals, then obviously we would have to consider it. It doesn’t mean we would support it.”
Peter Imhof, vice-president and portfolio manager at AGF Investments Inc., said the stock is a bit too small for him to own in the AGF Canadian Growth Equity Class fund. He also cited concerns in the market about Luxor looking to unload more of its shares, although Mr. Sprott’s investment is a positive sign.
“You always have to pay attention when he’s taking a big position in the company,” said Mr. Imhof, who used to work with Mr. Sprott at Sprott Asset Management.
Luxor has also granted Mr. Sprott a right of first refusal to buy another 16.2 million shares by the end of the year.