Tocqueville Gold Strategy 3Q17 - 100917 · Tocqueville Gold Strategy Third Quarter 2017 Investor...

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ContrarianMusicTocquevilleGoldStrategy

ThirdQuarter2017InvestorLetter

Gold appears to have formed a solid base since bottoming at year-end 2015 at $1060.00/oz. Through 9/29/17, the metal’s price increased 11.10%, even after a sharp pullback from its early September 2017 high of $1355. As of September 30, 2017, the price stood at $1280.15, 20.75% above its low at year-end 2015. In our view, gold and the precious-metals complex is in the early stages of a dynamic up-cycle that will match or exceed the run from 2000 to 2011. Downside appears limited; the greatest challenge for investors will be to muster the necessary patience to hang on until the up-cycle becomes more assertive and evident. Despite the four-year correction from $1900/oz. to $1060 at year-end 2015, gold has outperformed stocks and bonds since 2000, the dawn of radical monetary practices by the world’s central banks. We have shown the chart below in previous letters, and repeat it again here only to emphasize this under-recognized fact.

Despite this record, gold is deeply out of favor and dramatically underrepresented in the portfolios of wealthy families and institutions in the Western world. Gold mining shares

‐100%

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1999

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Gold S&P 500 Index S&P 500 Bond Index


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have uncharacteristically barely kept pace with the gold price (GDX, the most commonly followed mining-share ETF, has risen only 9.75% year-to-date). This tepid performance relative to the metal is one of many signs of prevailing negative sentiment. Despite modest gains year-to-date, gold mining shares remain sold out and very cheap in light of their upside potential, which will be driven by their own fundamentals as well as those affecting the gold price. Unsound monetary policy is the most important driver of our gold thesis. The exit from radical monetary policy will be difficult, if not impossible. On this point, we recently had an off-the-record conversation with a former governor of the Fed, who wholeheartedly agreed with this assessment. Gold is an efficient hedge against the real possibility that the Fed will be unable to exit its super-easy stance without triggering significant disruptions in financial asset valuations, imperiling already weak economic momentum, and destroying any pretense of fiscal sanity. A 1% rise in interest rates increases the federal deficit by 25% to 3.9% of GDP. The fiscal vulnerability is underscored by the fact that 50% of the debt matures in less than three years.

The US debt-to-GDP ratio is now 106%, a level that has historically been economically destabilizing to other countries and that has often led to blatant monetary printing and currency destruction. It is not just a U.S. problem, world-wide global debt burdens are sufficiently high that only small rate increases are required to inflict significant economic and market damage. Concern over North Korean nukes is commonly credited as the reason for gold’s push to new high ground this summer. Of course, we hope that these concerns prove to be transient.

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Also credited with gold’s recent strength, according to conventional wisdom, is the pronounced dollar weakness according to the U.S. dollar index (DXY), which blossomed during July and August. Keep in mind that gold rose from roughly $300 to $1900 from 2000 to 2011. That 11-year period encompassed intervals of both extended dollar strength and weakness. It is therefore incorrect, in our opinion, to attribute primary influence for gold’s direction to short-term fluctuations in the dollar exchange rate. In 1999 gold began to rally, and few could figure why. Anticipating proximate causes for major price trends is only speculation. Gold was well into a major upswing before the dot-com bust, 9/11, ultra- low interest rates, the housing bubble and mortgage-backed securities debacle, and the 2008 credit crash. These headlines of course fueled a bull trend that was already well underway. At the end of the day, price makes news and the headlines follow. The obvious lesson is that all markets, including gold, discount future events and that the development of prices in the absence of easily articulated causes must be respected. The prospects for gold and its price behavior today appear similar to those of the early 2000s. The gold price has been advancing for nearly two years for no obviously apparent reason. What we know is that the financial markets are bulging with systemic risk. Financial-asset valuations by many measures (see below) are at all-time highs; to our way of thinking, they constitute prima-facie evidence of significant risk.

Source: John Hussman

What we also know is that gold production is peaking out, and is likely to decline over the intermediate term even if gold prices rise substantially. Should investor demand reawaken, there is very little slack in supply to absorb it. The depletion of gold inventories in London


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and other Western vaults – a result of demand in Asia – is a finite process with measurable limits. There are many signs that those limits are being reached. Finally, we know that the fiscal position of Western democracies is perilous and worsening. History teaches that resolution of fiscal impasses most often results in monetary debasement, which has invariably led to a rise in the nominal value and purchasing power of liquid assets that cannot be debased. Gold and silver constitute a short list of non-financial assets with monetary characteristics. Fundamental facts that can be ascertained today rarely provide clues to the timing of what they portend. However, they help to gauge the potential for return on capital deployed in anticipation. As in the period from 2000 to 2011, the gold price moved well in advance of the headlines. However, it was quite possible to assess systemic risk by observing the extreme market valuations of the late 1990s. We believe that a reversion to the mean from the giddy financial-asset valuations of 2017 is inevitable, and that it will occur sooner rather than later. In contrast to the mainstream financial assets that the crowds seem to clamor for, gold and gold mining shares enjoy pariah status. That alone is music to our contrarian ears.

John Hathaway

Senior Portfolio Manager

© Tocqueville Asset Management L.P.

October 9, 2017

This article reflects the views of the author as of the date or dates cited and may change at any time. The information should not be construed as investment advice. No representation is made concerning the accuracy of cited data, nor is there any guarantee that any projection, forecast or opinion will be realized. References to stocks, securities or investments should not be considered recommendations to buy or sell. Past performance is not a guide to future performance. Securities that are referenced may be held in portfolios managed by Tocqueville or by principals, employees and associates of Tocqueville, and such references should not be deemed as an understanding of any future position, buying or selling, that may be taken by Tocqueville. We will periodically reprint charts or quote extensively from articles published by other sources. When we do, we will provide appropriate source information. The quotes and material that we reproduce are selected because, in our view, they provide an interesting, provocative or enlightening perspective on current events. Their reproduction in no way implies that we endorse any part of the material or investment recommendations published on those sites.

1

Gold Monitor Chart Comments (3Q 2017)

1. Real interest rates remain negative on global basis ( Fig. 1, 3, 5)…a

bullish sign for gold.

2. Central bank money printing and balance sheet expansion continues

on global basis (Fig. 2, 4, 6)…also bullish for gold.

3. Looming US fiscal train wreck (Fig. 16).

4. Barely any pretense of fiscal discipline (Fig. 18).

5. Ultra‐low interest rates mean any increases are potentially

destabilizing (Fig. 19, 20).

6. Foreign investors including central banks are divesting USD positions

(Fig. 22).

7. Bullish gold supply and demand fundamentals ‐ stagnant mine

supply and steady demand growth since 2009 (Fig. 24).

8. Investment sentiment remains negative (Fig 34, 35).

9. Mining shares are cheap relative to the gold price (Fig. 41).

10. Fundamentals improving for miners (Fig. 45, 46, 47).

2

Section I. Macro

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2000 2002 2004 2006 2008 2010 2012 2014 2016‐5%

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0%

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5%Fig.1. Gold and US Real Rates

US Real Rates

Gold ($/Oz)

Source: Bloomberg

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1995 1998 2001 2004 2007 2010 2013 2016

Fig.2. Fed Balance Sheet ($B)

Source: Bloomberg

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2000 2002 2004 2006 2008 2010 2012 2014 2016€ 0

€ 200

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Gold (€/Oz)ECB Real Rates

Source: Bloomberg

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1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Fig.4. ECB Balance Sheet (€B)

Source: Bloomberg

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14%Fig.5. Gold and PBC Real Rates

PBC Real Rates

Gold (¥/Oz)

Source: Bloomberg

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Fig.6. PBC Balance Sheet (¥B)

Source: Bloomberg

3

Section I. Macro

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Fig.7. The Biggest 6 Central Bank Balance SheetsUS, UK, Japan, China, EU & Switzerland (US$T)

Source: Bloomberg

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Fig.9. US M1 YoY%

Source: Bloomberg

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Fig.10. US M2 YoY%

Source: Bloomberg

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Fig.11. ECB M1 YoY %

Source: Bloomberg

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1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Fig.12. ECB M2 YoY %

Source: Bloomberg

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1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Fig.13. PBC M1 YoY %

Source: Bloomberg

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1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Fig.14. PBC M2 YoY %

Source: Bloomberg

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$0

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Gold

M2

Source: Bloomberg

4

Section I. Macro

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2011 2012 2013 2014 2015 2016 2017

Fig.18. The Debt Ceiling ($T)

Total Federal Debt

Debt Ceiling Limit

Source: Bloomberg

Source: Bloomberg, Shadow Government Statistics

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2000 2002 2004 2006 2008 2010 2012 2014 2016

Fig.19. Average Annual Interest Rate on US Debt

Source: US Treasury, Meridian Macro

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Fig.16. US National Debt ($T)

Source: TreasuryDirect.gov, USDebtClock.orgProjections are based on current rates

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1966 1976 1986 1996 2006 2016

Fig.17. Total Pubic Market Debt as % of GDP

Source: Stlouisfed.org

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1988 1992 1996 2000 2004 2008 2012 2016

Fig.20. Interest Expense as % of Total Government Outlays

Source: Bloomberg; US Treasury

Fig. 15. Inflation as of August 31, 2017

U.S. Euro Area China

Headline CPI 1.9% 1.5% 1.8%

Core CPI 1.7% 1.1% 2.2%

Shadowstats 9.2% n/a n/a

5

Section I. Macro

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1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Fig.23. China Net Purchases Long‐Term US Securities(annual US$B)

Source: US Treasury; MacroMavens, LLC

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Fig.22. Net Purchases of US Treasury Notes and Bonds by All Foreign Countries (US$B, 12 month sum)

Source: US Treasury; MacroMavens, LLC

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Fig.21. Global Forex Accumulation (US$B, 12 month sum)

Source: Bloomberg; MacroMavens, LLC

6

Section II. Gold

19.6%21.8%

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1934 1982 2016

Fig.25. Market Value of Above Ground Gold as % of Total US Financial Assets

Source: Federal Reserve, World Gold Council

0

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Oct‐03 Oct‐05 Oct‐07 Oct‐09 Oct‐11 Oct‐13 Oct‐15

Millions of Ounces

Fig.26. Gold Held by ETFs

All ETFS

SPDR Trust

Source: Bloomberg, Company Filings

Fig.24. Gold Supply and Demand (tonnes)

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Supply

Mine production 2,591 2,592 2,478 2,550 2,481 2,476 2,409 2,584 2,739 2,827 2,848 3,019 3,114 3,186 3,236

Old gold scrap 835 944 829 886 1,107 956 1,217 1,672 1,723 1,669 1,626 1,371 1,122 1,093 1,309

Traditional supply 3,426 3,536 3,307 3,436 3,588 3,432 3,626 4,257 4,463 4,495 4,473 4,390 4,236 4,279 4,545

Net producer hedging ‐412 ‐279 ‐445 ‐86 ‐373 ‐444 ‐349 ‐252 ‐108 10 ‐20 ‐50 42 ‐21 26

Official sector sales 545 617 497 662 367 484 236 30 ‐ ‐ ‐ ‐ ‐ - -

Total supply 3,559 3,874 3,359 4,012 3,582 3,472 3,513 4,034 4,355 4,505 4,453 4,340 4,278 4,258 4,571

Demand

Jewellery 2,680 2,522 2,673 2,707 2,283 2,405 2,187 1,760 2,017 1,972 1,908 2,198 2,153 2,455 2,042

Other 360 385 416 431 458 462 436 373 466 453 428 409 389 331 645

Total fabrication 3,040 2,907 3,089 3,138 2,741 2,867 2,623 2,134 2,483 2,425 2,336 2,603 2,542 2,786 2,687

Bar & coin retail investment 373 314 396 412 421 446 649 743 1,205 1,519 1,256 1,654 1,064 1,012 1,029

Official sector purchases ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ 77 457 535 369 477 588 383

ETFs & similar 3 39 133 208 260 253 321 617 382 185 279 ‐881 ‐159 ‐133 532

Implied net investment 143 614 ‐259 254 160 ‐94 ‐80 541 207 ‐81 47 595 354 5 ‐60

Total demand 3,559 3,874 3,359 4,012 3,582 3,472 3,513 4,034 4,355 4,505 4,453 4,340 4,278 4,258 4,571Source: World Gold Council

7

Section II. Gold

Investment Adviser, 19.9%

Broker, 4.6%

Private Banking, 6.6%

Pension Fund, 1.5%

Hedge Fund, 5.8%

Mutual Fund, 0.8%

Insurance Company, 0.2%

Non‐Institutional,

60.7%

Fig.27. SPDR Gold Trust Ownership by Type

Source: FactSet

‐800‐700‐600‐500‐400‐300‐200‐100

0100200300400500600700800

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Fig.29. Central Banks Net Purchases (tonnes)

Source: World Gold Council

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Fig.31. Gold as % of Total Reserves


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Fig.30 Central Banks Holdings of Gold (tonnes)


Fig. 28. Notable Transaction in 2017

Country Tonnes Transaction

Kazakhstan 27.6 Purchase

Russia 129.1 Purchase

Turkey 111.9 PurchaseSource: World Gold Council

8

Section II. Gold

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Fig.32. Web searches for "Gold Bubble"

Source: GoogleTrends

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Fig.33. Web searches for "Gold Investment"

Source: GoogleTrends

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Fig.34. Bernstein's Daily Sentiment Index

DSI

Gold

Source Bloomberg, Bernstein's DSI

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Fig.35. Market Vane Sentiment Index

MV

Gold

Source Bloomberg, Market Vane

9

Section II. Gold

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Fig.36. Comex Gold Futures Open Interest

Open Interest (tonnes; LHS)

Gold ($/Oz; RHS)

Source: Bloomberg

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2000 2002 2004 2006 2008 2010 2012 2014 2016

Fig.37. Gold vs Continuous Commodity Index Performance

CCI Index

Gold

Source: Bloomberg

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Fig.39. Commercial Net Shorts as % of Total Open Interest

Net Short/OpenInterestGold

Source: Bloomberg; The McClellan Market Report

More Net Short

Less Net Short

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Fig.38. Comex Gold Futures ActivityNet Large Speculators (tonnes; LHS)

Net Hedgers/Commercials (tonnes; LHS)

Gold ($/Oz; RHS)

Source: CFTC

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2003 2005 2007 2009 2011 2013 2015

Millions of Ounces

Fig. 40. Registered COMEX Gold Stocks vs. Owners per Ounce

Registered Stocks

Owners per Ounce

Source: Bloomberg

10

Section III. Gold Mining Equities

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1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Fig.41. XAU and HUI as a Ratio of Gold

HUI/GoldXAU/Gold

Source: FactSet

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Fig.42. Net Fund Flows For Morningstar's Equity Precious Metals Fund Universe ($M)

Source: Morningstar 2H16 is through 12/31/16

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Fig.44. Equity Capital Issued by Gold Miners

$B of Equty Issued

# of Transactions

Source: Bloomberg

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Fig.43. Market Cap of Van Eck Gold Equity ETFs ($B)

Source: FactSet

11


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Fig.45. Senior Producers Return On Capital

Source: FactSetUniverse: NEM, ABX, GG, KGC, AUY, NCM, AU, GFI, HMY

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Fig.46. Average Cost of Acquisitions in the Gold Sector ($/Oz)

Acquisition Cost As Ratio of Gold Price

Source: RBC Capital Markets, Bloomberg.

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20162017E

After Tax Cash Cost ($/oz) 209 210 253 311 363 413 552 738 661 814 987 1,10 1,08 988 903 880 900

Margin (%) 23% 32% 30% 24% 18% 32% 21% 15% 32% 34% 37% 34% 23% 22% 22% 30% 31%

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$0

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$1,000

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$1,400Fig.47. Gold Mining Industry Production Costs

After Tax Cash Cost ($/oz)

Margin (%)

Source: Tocqueville Asset Management, FactSet

12


Source: BMO Capital Markets

Fig.48. Gold Price Discounted by Market ($/Oz)

Fig.49. NAV Premiums – Senior & Intermediate Producers (N.A.)

Source: ScotiabankSource: Scotiabank

Fig.50. P/CF – Universe of Coverage AverageFig.51. Adjusted Market Cap per Oz of Resource

Divided by Gold Price

Source: BMO Capital Markets

Tocqueville Gold Strategy 3Q17 - 100917 · Tocqueville Gold Strategy Third Quarter 2017 Investor...

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