Sprott’s Thoughts On First Quarter in Review: Gold

gold spot prices are up 15% YTD and the HUI Gold Miner’s equity index up an impressive 70% over that same period. I need not remind readers that this price action is coming hot on the heels of a prolonged bear market, which had created a situation where the gold price was all but spring-loaded. Sellers have been selling down their assets for several years, and as of the beginning of the year they were exhausted with little left to sell– so when a flurry of buying activity began, there was, naturally, little left to buy. Prices moved accordingly.

But that activity paused in April. The pause we’ve seen in that momentum over the past few weeks is a healthy one that sets the stage for what is hopefully another leg higher for gold prices. Not surprisingly, gold’s move higher has corresponded nicely with a drop in the U.S. dollar as the (supposedly) data-dependent FED backpedaled in their rate hiking policy in the face of disappointing data. But as currency wars rage on, whether or not this too is just a pause in the dollar’s momentum higher remains to be seen.

Less discussed, but certainly as important, are reports of China’s intention to institute a yuan-denominated gold price fix. In the wake of last year’s breakup of the London gold price fix, China has become keen to exert a greater influence on the daily pricing of gold. This should come as no surprise, as they’ve been the world’s largest producer and consumer by a fairly wide margin the past few years. Reuters reports that the fix, which could come as early as this month, will be traded on the Shanghai Gold Exchange (1), which although reasonably new, is already the largest physical gold exchange in the world. What this ultimately means for Western bourses, which have historically been the primary drivers of global pricing, is yet unknown. But I believe this new, hungry competitor will act as pricing stabilizer and a source of liquidity, which all gold investors should welcome.

For China, gold is a very small part of the currency story. In 2005, China surprised the world with the announcement that they would peg the renminbi to the dollar. Why? They sought admittance into the IMF’s basket of Special Drawing Rights, which was created by the IMF in 1969 to create an internationally accepted reserve asset, to supplement the existing official reserves of member countries (2). Well, 10 years later, they got their wish. In November 2015, The IMF approved adding the renminbi to this basket, allowing them to join the prestigious circle with the dollar, euro, pound sterling and yen. But the peg also had unintended consequences on the Chinese economy. The strengthening dollar (and by extension, the strong renminbi) has eroded China’s global share of exports, a short term compromise that the Chinese were willing to make.

Now with their Special Drawing Rights status, the Chinese have unpegged the renminbi from the dollar and the “short-yuan” trade has become one of the most popular trades in global finance. The expectation is that China will deliberately inflate (depreciate) their currency to gain back their share of global exports. Anyone watching the massive levels of capital outflows from mainland China into hard assets around the world, with North American real estate markets being one of the most popular, will not be surprised. Gold is just one of their targeted assets. China has been vocal in their attempts to stomp out corruption amongst party officials and put a stop to these fund flows, but as we can tell from the recently released “Panama Papers,” what they’re doing privately is an entirely different matter (see specifically President Xi Jingping’s brother-in-law) (3).

The result? Gold had a record breaking first quarter with gold stocks faring even better. For example, the Sprott Gold Miner’s ETF (SGDM) was up over 62% from Jan 4 – April 11th, 2016.

For one, gold went from having the worst track record of any commodity/investment class to being the best performing, with seemingly no shortage of newly minted “gold bugs.” Obviously the FED had a hand in shaking confidence in the central bank’s ability to will the U.S. equity market higher, causing investors to look for gold as an alternative. Or perhaps it was the suggestion by New York Fed President Dudley to consider negative interest rates if the economy stalls further. Note this comment came during a speech he delivered on Jan 15th, within days of the recent bottom for gold prices (4). Maybe it’s just a coincidence.

The possibility of banks starting to charge clients for the courtesy of holding deposits sure seems to negate arguments from Wall Street naysayers that gold doesn’t generate any return – at least it’s not aknown loss. We have several examples of central banks around the world cutting rates below zero, Japan being the most prominent of the bunch. This is a policy aimed squarely at encouraging banks to lend, rather than to hoard cash. The banks don’t like this, as they expect low returns in equities and higher default rates for borrowers in 2016 and would rather hold onto their cash. The savers don’t like this, as they lose money simply through trying to save it. Gold, in this case, seems to be an ideal storage of value.

With that said, the price action since the beginning of the year gives me reason to believe we’ve already witnessed the bottom in the gold price. Gold stocks went from “stupid-cheap” to just “kind-of-cheap.” Silver has underperformed gold until very recently, but the silver equities have gone along for the ride nevertheless. This suggests one of two things: either silver continues to play catch-up here, or the silver equities start to give back some of these gains.

Remember, if you think gold prices are going up, the answer is simple, buy gold. But for anyone who wants to take advantage of the gold equities, I believe now is the time to establish (or re-establish) exposure.

There are numerous types of companies to consider depending on an investor’s risk tolerance ranging from royalties/majors to juniors/development names, not to mention the ever popular “optionality plays.” We at Sprott can help to determine which is right for you.

If you have any questions about this article, please contact your Sprott Global advisor, or the author, Eric Angeli at EAngeli@sprottglobal.com or 800-477-7853.

(1) http://www.imf.org/external/np/exr/facts/sdr.htm', ' href="http://www.imf.org/external/np/exr/facts/sdr.htm">http://www.imf.org/external/np/exr/facts/sdr.htm

(3) https://www.newyorkfed.org/newsevents/speeches/2016/dud160115', ' href="https://www.newyorkfed.org/newsevents/speeches/2016/dud160115">https://www.newyorkfed.org/newsevents/speeches/2016/dud160115