Description

GOLD

I recommend taking a long position in Barrick Gold, which is a Canadian mining company listed on the Toronto Stock Exchange under the symbol ABX, and trades on NYSE under the symbol GOLD. Barrick Gold is one of the largest gold mining company (current market cap is $38B) and is the 2nd largest component of the gold miner ETF GDX. It primarily produces gold and copper, and also engages in mine exploration and development. It’s geographically diversified; having 14 producing gold mines including 6 tier one gold asset (defined as having a reserve potential to deliver a minimum 10 year life with annual production >= 0.5M ounces of gold and total cash costs per ounce over the mine life in the lower half of industry cost curve). FY2020 revenue: gold $11.67B (92.6%), copper $697M (5.5%), other $228M (1.8%). Given that the majority of revenue is from gold, this writeup will mostly focus on why buying GOLD is a good way to play the coming gold rally.

Why I think gold price is likely to appreciate over the next few years.
(1): Gold price is likely to rise substantially when central banks engage in large scale money printing and during inflationary time period. This was true in 2008, 2001, 1971; and surely would also be true during the 1930s if gold price was allowed to fluctuate freely. The mechanics is very simple. If the monetary system is gold standard, central bankers must devalue currency against gold in order to print money. If the monetary system uses fiat currencies, even without the explicit need to devalue against gold, money printing is still very likely to cause currency devaluation against gold and other storeholds of wealth, because those printed money will be used to purchase assets pushing up their prices. There is no guarantee that investors will allocate certain percentage of portfolio to a useless asset like gold to hedge inflation, but that’s what happened in the past and I believe it will continue to happen going forward.

However, this simple fact was obscured by the rapidly changing market psychology since the outbreak of COVID. Initially during March 2020, gold price dropped from $1650/oz to $1500/oz due to liquidity concerns; then it rapidly recovered and climbed to a high price of $2050 in August 2020 probably due to heightened uncertainty because we had no idea how terrible COVID would be in Q2 last year. Then gold price started to drop and fluctuated around $1800 over the past 12 months. As we continue to roll out vaccines and gradually move back to a normal life, investors shifted their attention to “re-open play that benefits from pent-up demand” and away from “we should buy gold because of so much money printing”.

(2): The important thing is that spot gold price has only risen from the pre-COVID price of $1500 to $1823 now, about 22%; while the Federal Reserve balance sheet has rapidly grown from $4T to $8T in just 18 months and US public debt as a percentage of GDP is at historical high of over 120%. Simply put, gold price has not risen enough for the current round of money debasement. Also this COVID money printing is likely to have a much bigger impact on subsequent inflation than that of 2008 GFC; printing to replace lost income is a lot more inflationary than printing to replace credit because it doesn’t replace/increase the supply those incomes were paying for. We’re already seeing early inflation signs in the recent CPI numbers.

(3): Gold price is low from a relative standpoint now compared with historical numbers. For example, if we look at A = (USD value of all above ground gold) / (total M0); B = (USD value of all above ground gold) / (total market cap); C = (Percentage of Central Bank Reserve in Gold); these are all at historical low. Most investors don’t pay much attention to this fact and have become very comfortable with the safety of fiat money, because inflation hasn’t been a problem during their lifetimes. As a result, very little of the newly created paper money was allocated to precious metal assets like gold. The low relative price is also made clear by the following inflation adjusted gold price plot.

(4): Buying zero-yielding assets like gold in the current environment is not bad. Most people on this website probably have heard about the famous Buffett quote about gold: “…… You can fondle the cube, but it will not respond.”; and conclude that gold investing (without detailed analysis of near term industry supply-demand) is essentially playing the greater fool game. Buying gold is essentially betting on other investors to follow suit due to fiat money devaluation fear; this is still true. But there is also an economic reason to switch from cash/bond to gold, because right now a high percentage of cash/bond is expected to have negative real yield and the yield of gold is always zero. As we run out of sensibly priced equity assets to buy, investors in aggregate, eventually will have no choice but to buy real diversifier like gold or bit coin, etc.

(5): Despite the emergence of bitcoin and other crypto currencies; large institutional investors will still likely to buy gold to hedge inflation/stagflation. BTC is only 12 years old; which is not long enough to prove its reliability; there is always the possibility of some newly invented crypto currency replacing bit coin. In contrast, gold was universally accepted as storeholds of wealth for more than 2000 years. Secondly, bit coin, and all other major crypto currencies are very volatile; and likely will continue to be volatile, making them not suitable for inflation hedge. Lastly, total BTC market cap at $31500/coin is only about 4.5% of total gold value; so even if investors allocate a portion of “inflation hedge” buying power into BTC, gold is still likely to see large buying pressure pushing up its price.

Why I think GOLD is a good buy.
(1): Barrick Gold has solid balance sheet with very little net debt after consistent debt pay down over the past 7-8 years. There is no significant pub debut maturities until 2033. FY2021 full year guidance is for production of 4.4M ~ 4.7M oz; with cost of sale $1020 ~ $1070/oz and AISC $970 ~ $1020/oz; under the assumption of gold price $1700/oz. The sensitivity of per oz cost with respect to gold price +/-$100 is $4. (i.e. if gold price rise $100, per oz cost would rise by $4). GOLD stock price dropped over the past few month due to earnings drop in Q1 as a result of lower realized gold sale price and sale volume. Current price vs trailing 12-months P/E is about 15.
(2): Buying a major gold miner is better (or put more bluntly: more aggressive) than buying physical gold due to its operating leverage. Although gold miners will experience higher production cost when gold price rises because of inflation (higher royalty payment; higher labor cost, etc); overall a well capitalized, low debt gold miner will still have a much larger percentage appreciation compared to owning physical gold. Of course you can also buy GLD (an ETF that holds physical gold bullion with expense ratio 0.4%) to long gold directly.
(3): Lastly, this thing is called “GOLD”!

Catalyst

investors start to buy gold as inflation materialize