Gold Continuing Basing Action #80

by Barry Dawes

Key Points

  • US$ Gold price continuing basing action after breaking 2011 downtrend
  • Gold in other currencies showing strength
  • Australian Gold Sector operating very well
  • Australian gold mine production, resources and reserves growing strongly
  • New record gold mine output likely in 2018
  • ASX Gold stock prices firm and ready for further rises
  • A$ to remain firm and rise from these low levels.

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Since the first publication of Dawes Points in 2013 the theme has been a global economic boom that would involve strong equity markets and commodities and weaker global bond markets and would lead to a higher A$ and a very much higher gold price.

These projections were made against a backdrop of falling commodity markets, falling resources equity markets, a continual avalanche of negative commentaries on China and the `Greater Depression’ unfolding in the US.

This oncoming Dawes Points benign environment would simply support a very robust Australian resources sector with a strong A$ that would keep everyone honest and to increase the wealth of all Australians.

The concept of a financial Armageddon was rejected and the driver of a strong US$ gold price would be demand/supply and not gold’s role as the asset of last resort in some sort of collapse.

It is pleasing to see that most of projections have come to pass.  The US, German and most major Asian equity markets have continued to rise and even managed to produce new rally and/or all time highs in this Dec Qtr 2018.  The recent correction should be just a correction.

Economic growth is strong and commodities are rising from their previous lows as they achieve continuing record high consumption levels and limited new supply. Even iron ore seems to be on its way to the forecast (Dawes Points #51 July 2016) of new highs over the next few years.

The Dawes Points Wave View is still looking very good although it is taking longer than expected.

The impact of good economic data on the Australian resources industry has been mixed.  It has generally disappointed in share market performance and has suffered from low market participation and, in my view, from a complete misallocation of capital.  Why is it that the A$2800bn in superannuation money is so risk averse and unsupportive of new resource or agricultural investment in Australia?

The market requires more participants and capital to more accurately reflect the underlying value generated by managers in the current commodity environment.

The big companies have reported strong earnings, balance sheets and dividends but market interest has been limited. From my long experience in this Australian Resources Market it has been perpetually clear that it is truly a rising US$ gold price that really drives market interest. And we are waiting.

Shortages in nickel, rare earths, uranium, graphite, cobalt, iron ore, oil or copper can provide short term fluctuations and excitement in a particular sector but it is the US$ gold price that brings in investors to expand the overall market participation.

So hence the preoccupation with the meanderings in gold prices.

So where are we now?

The long term view for us here starts with the abandonment of the 1944 Bretton Woods Agreement in August 1971 when President Nixon shut the convertibility of US dollars into gold in August 1971 and thereby ending the Gold Standard. This allowed currencies to float and gold to determine its own level.  It also allowed politicians and bureaucrats to play and meddle with currency and bonds.

This graphic says after the 1980 US$887/oz gold price highs, a 20 year pullback brought gold back to sub US$250/oz in 2000/2001 before resuming the bull run.

The 2011 downtrend has been clearly broken but US$ gold has pulled back to retest that downtrend.  This action is very positive even if the 2001-2018 uptrend has apparently been broken.

Notable here is that the time frames involved in gold moves are substantial and for many, patience does run out.

It is now late 2018 so we have had a bullmarket that began almost 20 years ago, the most recent spike high was over seven years ago and we have had five years of trench warfare in the US$1050-1375 range.

This five year base has been grinding and the trench warfare has discouraged many investors and followers.

Nevertheless, as discussed previously, markets often exhibit a symmetry and in this five year base we had about 30 months from the July 2013 low to the important December 2015 low.  It was a further ~30 months from that Dec 2015 low until the August 2018 low.

So to keep this symmetry we should see US$ gold meander but then move up to ~US$1370 for another test, then a short pullback and then hopefully much higher.

Time frame is about 3-4 months, but, who knows.  The runups in 2017 were suggesting breakouts then but we saw no follow through then so we do have to just wait.

Gold also broke the April 2018 downtrend after forming and breaking out from a wedge.  This is very constructive.

When US$ Gold does break out of this trading range, the speed and the price level in gold, will, in my view be powerful and high.

So what will be the drivers?

The Dawes Points view has been that demand from China and India has been absorbing all available gold from the West leaving it underweight and `short’.  This demand is likely to continue and also grows with rising living standards so that there will soon be very little freely saleable gold left in the West and thereby this demand will be driving the US$ gold price much higher.

The demand numbers are large. Above ground gold is generally estimated at around 180,000 tonnes being all the gold ever mined. The demand from China and India since 2008 has been 26,000 tonnes or 14% of all gold in existence.  Annual demand exceeds Western mine production.


Global gold mine production of gold is about 3300 tonnes of which China contributes around 400t and Russia about 260t leaving the West producing about 2650t.

Recycled gold scrap is about 1200tpa.

Western demand for gold in the form of bars, coin, jewellery, industrial demand is around 1500tpa and Central banks are buying about 500-600tpa.  So this is at least 2,000tpa leaving only 1700-1800t surplus.

The data shows Asia is importing over 3,000tpa. With the transfer of so much gold to Asia the net market in the West has been in demand/supply deficit over well over 1,000tpa for the past few years with the drawdown of gold coming from Western inventories from wherever.

Strong evidence of this is available in gold flows of 400oz London Bullion Market bars from the UK to Switzerland to be refined into 1kg bars for delivery to Asia.  Little evidence is available of the flow of these 1k bars back to the West.

The overall market is now in Deficit on the basis of this supply demand model.

So the gold market is in this Deficit position with gold buying being `met’ by sales of futures contracts that have no real physical backing.

Hence, seeing the net position as well as 3000tpa to China and India it is clear that the West has been running down its available gold inventory.  Who used to own this inventory and is there any left?

Demand/Supply should soon lead to a short cover rally in gold that should bring prices up to US$1375 and then drive it much, much higher very quickly.

Gold ETFs are expected to see rising holdings in a rising gold market so this will add even further price pressure.

Gold in Currencies

It has already been noted that gold in US$ has already broken its 2011 downtrend.

Gold in Swiss Francs has also broken its downtrend as has gold in British Pounds.

However, gold has not broken this downtrend in Euros (but it is certainly getting ready to do just that).

Nor in A$, but also the trendline break seems to be very close.

Australian gold mining producers have done very well.

However, the gold price in various currencies is really relating to the US$ itself.

Where are we going here with this US$ Index?  I really don’t know.

This DXY Index at 97.38 is still below the 2017 high of around 104 and the technical pattern here provides no real indication of future direction.

However, there are several factors worth noting here that may influence future levels of the US$.

  • Treasury Bonds prices are weakening due to
      • Increasing deficits increasing supply of bonds
      • Inflation rising
      • Less need for safe haven for funds
      • The US Fed is allowing its T-bonds to mature and not rolling over

It is hard to see a strong currency when its bonds are falling.

  • Leveraged hot money inflows to the US$ from currencies with very low interest rates
      • GoldMoney estimates US$5tn of this inflow – some unwinding possible
  • The Euro makes up 57% of the DXY and debt problems from Italy et al may weaken that currency.
    • Note that the now-sub 113 Euro is making 17 month lows against the US$
  • A strong US economy will help all other economies and encourage capital outflow from the US

Whatever is happening it is more likely to be inflationary outcome than a deflationary outcome.

The next few months might clarify these issues as well and take the pre-occupation with US issues and bring the focus back to the Australian mining sector.

Australian Gold Sector

The A$ gold price has averaged above A$1600 for a number of years and has helped the Australian gold sector to mine profitably again.

There is also a renewed vigour in the Australian Gold Mining Sector that is a testament not just to a higher A$ gold price but also to the entrepreneurial skills of the sector and the recognition of the still substantial potential of the Yilgarn Archean Greenstone Belt in WA that produces over 50% of Australia’s gold mine output.

The activity is most impressive and gold mine production is increasing.

Australia’s gold mine production will exceed 300tonnes (~10moz) in 2018 and looks set to climb further in the next few years.  Quarterly data up to June 2018 shows this clearly.

In addition, several new mines in 2018/19 will add significantly to output with Kirkland Lake’s Fosterville likely to bring as much as another 300,000oz in 2019 from the Swan Zone (1.16moz @ 61g/t!) alone with stope ore grades of over 70g/t and average mill grades close to 30g/t.

2018 should also see record gold output and exceeding the previous high of 3012 in 1997.

Dawes Points also sees considerable potential in WA coming from the Pilbara as well as the Yilgarn.

New important hard rock resources have been established by De Grey Mining, Callidus and Kairos that are showing the Pilbara can deliver orogenic gold.

The Pilbara Gold Conglomerates also have very great potential and I am a believer here.  Novo Resources may actually have three mining operations underway by the end of 2019.

The use of ore sorters is likely to significantly lower processing costs by reducing the tonnage to be treated.  Conglomerate grades of even 1-2g/t can be significantly upgraded for mills having to treat just, say, 15% of the ore feed and yet recover 70-85% of the gold.

Don’t rule out another 1-2mozpa coming from the Pilbara conglomerates at very low operating costs into 2020 and beyond.

I made a presentation on the Pilbara Gold Conglomerates at the Precious Metals Investment Symposium in Perth last month. The data is compelling.  Copies available on request.

The key gold producers on ASX have also been providing an impressive growth trajectory with a selected group of 21 companies providing 4.5moz production in FY18 giving a 13% CAGR since FY14.

Northern Star, Regis, Evolution, St Barbara and Saracen have provided most of the growth.

Australia’s biggest gold producer Newcrest has had a few technical issues that have limited its production growth but have produced another 2.3moz from its mines in Australia and elsewhere.

The pace of exploration is also picking up with nominal exploration expenditures likely to make new highs during 2018.

The commitment to exploration and development has seen the JORC Resources of these 21 key companies grow by 30% over the past four years to 135moz at an average CAGR of 7% with the share of Measured and Indicated rising from 63% to 70%.  This is net growth after annual production which is now over that 4.5mozpa. Newcrest hasn’t been so fortunate but has one of the world’s largest resources base with very long mine life at Cadia and Lihir and its time will come soon.

This resources growth is almost always extending mine lives, not just adding new projects.

Reserves have risen faster and for these 21 key companies are now 70% higher at 50moz than in 2014 with a 14% CAGR.

Over the past four years, these 21 stocks in this sector have added almost 40moz give a net increase of 20moz after producing over 19moz.

Again Newcrest is consolidating its resource and reserve base but has numerous exploration plays that should add significantly to resources and reserves over the next few years.

These companies have reported excellent earnings and balance sheets are now in extraordinarily good shape with cash levels unheard of in the Australian mining industry over the past 30 years. CRA, MIM, NBH, WPL,  STO etc never had these cash levels in the 1980s, 1990s and 2000s.  It was usually debt that was the key feature of their balance sheets.

Strong cashflows and good balance sheets allow continuing capital reinvestment and also a robust dividend stream.

The dividend flow has been steadily rising as EVN, NST and RRL have paid out an increasing share of earnings and SBM, OGC and NCM have returned to the dividend paying list.

The very profitable East Kundana Joint Venture between NST and TBR/RND has resulted in some very good earnings numbers and shareholder activism has forced a special dividends of a gross A$250m (before TBR/RND cross shareholdings).  Many MPS clients received TBR dividends in excess of their entry prices for the shares!

Investors who picked up on Dawes Points mantra that `gold stocks will be better dividend stocks than banks’ have done well.

The ASX S&P All Ordinaries Gold Index has performed well since the Nov 2014 low but it has failed to properly reflect the Australian Gold Industry.

The 2011 downtrend has been broken here as well and has done a good retest of the downtrend and is now ready to head higher again.

Australian Gold Stocks have been leading the world in the current reflation after bottoming in November 2014 and after the pull back from the July 2016 highs the XGD is moving up to test the 5300 level again.

This has been a very volatile market so getting the timing right is very important.

A break through 5300 should signal a strong push through with the Gold Sector being well backed by production growth, resources increases and earnings with good balance sheets and rising dividends to further help drive this market.

However, a strong US$ Gold Price makes it all happen much faster.

This Correction Graphic shows that this XGD Gold Index is still playing catch up to the previous highs in 2011.

As noted, this ASX S&P XGD Index does not reflect the Australian Gold Industry and the large weighting to major gold producer Newcrest together with some irrelevant companies like Alacer distorts the true picture further.

It also gives no relevance to exploration companies or smaller companies.

This unweighted index of ten important Australian based companies with predominantly Australian production has totally outperformed the XGD Index but also Australian based companies with offshore gold production.

Being on board the Terrific Ten led by Northern Star has been the place to be but many stocks outside this Index have performed worse than even the offshore producers.

Ask me about the stocks that might be best for your portfolios.

The Australian gold sector is certainly outperforming its North American counterparts where the XAU is really struggling. This graphic suggests (who can really tell here!) a further test of the downtrend but it seems constructive.

Nth American Gold Stocks are pretty well despised and ignored by investors there and are at horrendous lows against the S&P 500 general market.  A wedge is forming so there might be some strength showing through over the new few months.

Don’t forget this long term relationship between the XAU and the US$/A$ rate.

And then what this looks like with the 1913 105 year downtrend only ~US$0.05 away at a time when calls for a lower A$ are ringing.

And you might to ask yourself what does this mean for the world if the A$ against the Euro breaks this wedging and jumps up sharply?

And here, also wedging against the British Pound?

It probably means gold’s strength will soon be showing.

Call me to discuss

Barry Dawes  BSc F AusIMM (CP) MSA AFA

Executive Chairman
Martin Place Securities

I own NST, TBR, KLA, BLK RIO, BHP mentioned in this report.

+61 2 9222 9111

13 November 2018