Gold regains its shine
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One thing markets have great difficulty putting a price on is uncertainty, and the good news for gold is that markets are beginning to reflect this, says VanEck's Arian Neiron.
The gold bullion price ended 2016 at US$1,146 and has since risen 7.4 per cent in 2017 to US$1,231 per ounce1. Gold mining stocks, which provide leverage to the gold price, have enjoyed a surge in 2017 with the VanEck Vectors Gold Miners ETF gaining 11.29 per cent year to date2.
Gold is largely responding to Trump's failure to provide clear details on how he plans to make America great but there are also other factors that are driving the demand for gold in 2017.
The Trump effect
Initially after Trump won the presidential election in November, markets were riding a wave of euphoria. Trump's potential policies to promote growth such as tax cuts, infrastructure spending, and changes in the regulatory climate, were all boding well for equity markets.
Not a typically bullish scenario for gold, and as a result, the gold price tapered off at year end.
Since Trump was sworn in as US president his proposals have been met with ambiguity. More particularly, his proposal for Mexico to "pay" for the wall via a tax on Mexican imports and the implementation of his immigration policy have caused markets to reassess what a Trump presidency may actually mean.
Markets are fairly good at pricing in demand trends, earnings expectations, technology innovations and many other things. However, one thing markets have great difficulty putting a price on is uncertainty.
So far, Trump's administration appears to be unconventional, controversial, and unpredictable. The markets seem obsessed with Trump's actions and statements, or perhaps even more so, his tweets.
The good news for gold is that markets are beginning to reflect this uncertainty.
While the Trump administration has the potential to implement policies that promote growth, it seems there are several risks that could impact the administration's efforts this year, including Fed tightening, potential moves by China or Russia, disarray in the EU, and strife the Middle East to name a few. We believe many of these risks will surface this year to gold's benefit.
Other factors supporting the gold run
While the Trump factor is supporting the gold run, there are other major obstacles that will likely see gold rally further in 2017.
Firstly, the tremendous debt the US is carrying is a significant concern. The tax policies outlined in Trump's campaign would raise US debt levels by trillions of dollars over the next 10 years.
And the US simply can't sustain more debt. Secondly, the US is in the late stages of the current economic cycle. This expansion has been going on for about seven years now, and expansions do not go on forever.
We think there is a chance the next recession could happen in Trump's first term. If the Fed raises rates as it has announced, there will be even more drag on the US economy.
Thirdly, a source of demand that has just come into view is the Middle East, where there has been a change in Shari'ah law.
Previously, there was uncertainty about whether Islamic countries could invest in gold bullion or gold stocks. The authorities there have now adopted an interpretation of Shari'ah law that enables individuals and institutions to invest in gold bullion, gold coins, and gold stocks.
This is especially important for institutions like the sovereign wealth funds and high net worth funds. We think gold will be a new investment choice for those types of investors, and it could bring additional demand to the gold market.
Finally, if you look back historically since Nixon abandoned the gold standard in 1971, there have been seven new US presidents inaugurated to the White House prior to Trump.
In the year following five out of seven of those inaugurations, gold has outperformed equities.
Table 1: Performance of the gold price compared to the S&P 500 following the inaugurations of seven new US Presidents
Source: Merk Investments. Past performance is not a reliable indicator of future performance.
There are numerous ways to gain exposure to gold. We prefer gold mining stocks due their operational leverage. Currently, gold stocks have around a 2-to-1 leverage to gold.
Over the past couple of years, gold companies have increased efficiency by improving their cost controls, operating results, and overall financial discipline.
Even though gold mining stocks have doubled since their low in January 2016, they are still 60 per cent below their 2011 highs and relative to the gold price are still the cheapest they have been since 1940.
The following chart compares the Barron's Gold Mining Index (BGMI), which dates back to 1938, against the gold price, showing it remains well below its previous lowest level.
Chart 1: Gold mining stocks at their cheapest level in history
Ratio of the price of miners to the price of gold Barron's Gold Mining Index/Gold Price
Source: VanEck, Bloomberg, Goldlynx; as at 20 January 2017
Investors can buy a diversified portfolio of 51 large and medium gold mining stocks in a single trade on the ASX by investing in the VanEck Vectors Gold Miners ETF (ASX: GDX).
1 Gold bullion price as at 15 February 2017 USD
2 GDX has returned 11.29 per cent in A$ terms year-to-date (YTD) to 15 February 2017
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Arian Neiron is the managing director of VanEck Australia. VanEck is a leading global provider of exchange traded funds (ETFs). This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.
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