Van Eck gold report forecasts more M&A in the sector

Joe Foster, Portfolio Manager for the Gold and Precious Metals strategy at VanEck, reports that the gold price changed very little in May, recovering towards the end of the month after early weakness brought on by the French presidential election and the FOMC (Federal Open Market Committee) meeting.

Foster writes that from the first round of the French elections on April 23 to the final round on May 7, markets became increasingly convinced that the pro-EU candidate Emmanuel Macron would win the election.

“This pressured gold as the risk of a Marine Le Pen-led Eurozone break-up lessened. On May 3, comments by the Federal Reserve (Fed) following its May FOMC meeting convinced the market that a rate increase following the June 13 meeting would be likely. Gold hit its low for the month on May 9 at USD1,214 per ounce, but was able to regain lost ground to end the month up USD0.65 (0.05 per cent) at USD1,268.94 per ounce.

“Weakness in the US dollar also added support for gold during the month. The US Dollar Index (DXY)1 fell 2.1 per cent in May and appears to have entered a bearish downtrend since reaching multi-year highs in early January. Economies in Europe and Japan have stabilised recently and the Trump administration has indicated a desire for a weaker US dollar. Gold should benefit if the US dollar trend seen so far in 2017 continues,” Foster says.

Foster also reports that physical gold demand from India and China has also been supportive of gold prices. “We believe healthy demand in March and April along with anecdotal comments from analysts suggest that 2017 is shaping up to be a much better year for gold in Asia,” he writes.

“Last year’s liquidity squeeze caused by the currency transformation in India seems to have dissipated and people are again making gold purchases. In China, bond market turbulence associated with government efforts to rein in debt and speculation have spurred investment demand for gold.”

The juniors and some mid-tier gold miners have underperformed the larger producers over the past two months with no significant change in gold bullion prices, Foster writes. “We find no fundamental reason for the underperformance, and therefore expect some mean reversion to favour the juniors in the second half of the year.”

Foster also observes that the Trump trade is unwinding. He writes: “Presumably, the belief was that pro-growth policies would ignite animal spirits in the markets that would stimulate business and prosperity. As President Trump has struggled to implement policies and his administration has been dogged by controversy, the Trump trade has unwound. Metals such as copper and iron-ore have given up much, if not all, of their post-election price gains.

“Gold has rebounded from its post-election losses. Interest rates have subsided and the DXY has fallen to pre-election levels. The one asset class that appears to still believe in the reflation trade is U.S. equities. As we write, the S&P 500 Index has reached new, all-time highs. In the past year, the likes of Apple and Tesla have posted gains of more than 50 per cent.
Top three junior positions in the Van Eck gold fund became targets of corporate activity in May: Gold Road Resources (2.3 per cent of net assets); Continental Gold (3.0 per cent of net assets) and Integra Gold (3.0 per cent of net assets).

Foster writes: “We were early investors in each of these gold development companies and have visited each of their properties. We increased our positions as they added value to their projects. Our conviction grows when a large gold company, with their teams of geologists and engineers, decides one of our portfolio companies is of strategic importance. We can’t remember ever seeing three of our companies receiving such attention in a single month.

“This is a reflection of the current growth strategy in the sector. In past cycles, large companies have been guilty of overpaying for acquisitions and destroying value. They would wait until a junior advanced a project to the point of construction. Instead, producers are now taking strategic equity stakes at an earlier stage in companies with properties they believe will develop into mines. That way, if they pull the acquisition trigger, they don’t have to pay a premium on the portion they own. Eldorado used this strategy by taking a 15 per cent stake in Integra in 2015 at CAD0.28, versus the CAD1.21 they are now paying for the portion of Integra they do not own.

“Acquisition activity has been subdued in the sector, while strategic positioning has become a frequent occurrence. In some cases, two producers have taken a strategic stake in the same junior developer. Not all gold properties become profitable mines and not all producers will have the same success that Eldorado has had with Integra. Gold production is no longer growing globally and many companies will face declining production in the years to come. To offset this, once the current phase of strategic positioning has run its course, we believe there will be another robust M&A cycle, possibly beginning in 2018.”

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Beverly Chandler
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