Sprott Gold Report: Why Gold and Gold Equities Can Thrive in 2018

Authored by Shree Kargutkar, Portfolio Manager, Sprott Asset Management LP

Gold Bullion Gained 3.23% in January

With the beginning of the new year, we have entered a seasonally strong period for gold bullion and gold equities. Gold bullion posted a strong gain of 3.23% in January, ending the month at $1,345.15 per ounce. While sentiment towards gold has improved from frigid to lukewarm, sentiment towards precious metals equities remains downright bearish.

We view this as a positive sign for precious metals equity investors with a long-term horizon because a shift in sentiment towards an asset class is usually followed by robust gains, which are primarily driven by re-rating of its valuation multiples. In the case of precious metals equities, multiples have continued to trend lower, making stocks cheaper while gold bullion has appreciated in price. We track investor positioning using a number of metrics including fund flows, gold futures trading and ETF flows. Gold bullion ETF flows serve as a good proxy for investor positioning, and options trading on GLD1 helps us to gauge sentiment. As shown in Figure 1, the shares outstanding in gold bullion ETFs are currently at a three-year high. When seen against the backdrop of rising asset prices, the increase in gold bullion holdings, is merely par for the course.

Figure 1: Total Known ETF Holdings of Gold (Oz) (1/2015 – 1/2018)

Figure 1: Total Known ETF Holdings of Gold (Oz) (1/2015 – 1/2018)

Source: Bloomberg. Data as of 1/26/2018.

Curiously, the shares outstanding in GDX,2 which is the largest gold mining ETF, remain near their three-year low, reinforcing our thinking that North American investor positioning in the precious metals mining space remains relatively lean. On the same note, silver, which has often acted as a high beta cousin to gold bullion, has not attracted much investor attention of late. Total silver bullion ETF holdings have continued to languish over the past 18 months. This serves to inform us that while investors have continued buying bullion as an insurance policy for their portfolios, investors are not currently seeking leverage to their gains from the potential rise in the price of gold, which gold and silver mining equities have typically provided. Similarly, we see relatively neutral levels of participation by investors and speculators in the gold futures market.

2018: Not Likely to be a “Normal” Year

Normally, these developments might indicate that we are in for a “normal” year for gold. 2018, however, is not likely to be a normal year in our estimation. With the passage of the Tax Cuts and Jobs Act in the U.S. at the end of 2017, the Republican Party signaled its willingness to dive deeper into debt during a time of economic expansion. The cost of this bill is expected to top $1.5 trillion over the coming decade (see Trey Reik’s commentary: Just Get Tax Reform Done!). On top of this colossal debt burden, there is signaling for further additions to the deficit as the House and Senate try to put together an infrastructure plan which would cost upwards of $1 trillion. The lack of fiscal restraint was well telegraphed by the incoming Trump administration in 2016, at a time when the economy was gaining steam and monetary expansion was firmly in place.

Signs of Inflation are Materializing

Fast forward a year, and we now have a situation where the U.S. Federal Government’s balance sheet continues to expand, the Federal Reserve remains dovish, the fiscal deficit is set to rise quickly and the U.S. economy continues to hum. Has anyone mentioned inflation yet? We are beginning to see inflation materialize. Energy prices are up, producer prices are on the rise and against all odds, wages are finally beginning to increase. It is no wonder that the combined effect of the factors above are weighing heavily on the U.S. dollar.

The Almighty U.S. Dollar? 

Indeed, in our estimation, one of the most significant developments of 2017 was the decline of the U.S. dollar, which lost almost 9.87% (DXY3) of its value when measured against a basket of other major currencies.

Figure 2: The Declining U.S. Dollar
DXY Index Measured Daily

Figure 2: The Declining U.S. Dollar

Source: Bloomberg. Data as of 1/26/2018

 Figure 3: U.S. Dollar (DXY) vs. Gold (XAU4(1/2015-1/2018)

Figure 3: U.S. Dollar (DXY) vs. Gold (XAU4) (1/2015-1/2018)

Source: Bloomberg. Data as of 1/26/2018.

As you can see from Figure 3, a declining U.S. dollar benefits gold prices. We believe that pressure on the U.S. dollar is likely to continue in 2018 on the back of increasing inflationary pressures, non-existent fiscal restraint and a dovish incoming Fed Chair (Jerome Powell). In January, the U.S. dollar broke below the important 90 threshold, and declined 3.25% (from 92.124 to 89.133 based on the DXY).

When the currency of a nation declines from increasing debt in an environment of easy money policies and artificially low interest rates, the perfect environment is created for gold to thrive. This is what we are facing today, similar to what we saw between January 2003 and December 2006 when gold prices climbed more than 80%, from $350 to $635 per ounce, while the U.S. Dollar Index (DXY) lost 18% of its value. It is no surprise that the rapid appreciation in gold also attracted speculative interest in gold equities, which saw the widely followed HUI Gold Index rise 142% in the same period.

As my colleague Trey Reik explained last month in Sprott Gold Report: 2017 Redux:


1 SPDR Gold Shares (GLD) is an exchange-traded fund and is used as a benchmark to measure gold bullion prices.
2 VanEck Vectors Gold Miners ETF (GDX) tracks the overall performance of companies involved in the gold mining industry.
3 The U.S. Dollar Index (USDX, DXY) is an index of the value of the U.S. dollar relative to a basket of foreign currencies.
4 XAU is an index of precious metal mining company stocks that are traded on the Philadelphia Stock Exchange.

The information contained herein does not constitute an offer or solicitation by anyone in any jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation.

Forward-Looking Statement

This report contains forward-looking statements which reflect the current expectations of management regarding future growth, results of operations, performance and business prospects and opportunities. Wherever possible, words such as “may”, “would”, “could”, “will”, “anticipate”, “believe”, “plan”, “expect”, “intend”, “estimate”, and similar expressions have been used to identify these forward-looking statements. These statements reflect management’s current beliefs with respect to future events and are based on information currently available to management. Forward-looking statements involve significant known and unknown risks, uncertainties and assumptions. Many factors could cause actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results, performance or achievements could vary materially from those expressed or implied by the forward-looking statements contained in this document. These factors should be considered carefully and undue reliance should not be placed on these forward-looking statements. Although the forward-looking statements contained in this document are based upon what management currently believes to be reasonable assumptions, there is no assurance that actual results, performance or achievements will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this presentation and Sprott does not assume any obligation to update or revise.

Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any fund or account managed by Sprott. Any reference to a particular company is for illustrative purposes only and should not to be considered as investment advice or a recommendation to buy or sell nor should it be considered as an indication of how the portfolio of any fund or account managed by Sprott will be invested.

Past performance does not guarantee future results. The views and opinions expressed herein are those of the author’s as of the date of this commentary, and are subject to change without notice. This information is for information purposes only and is not intended to be an offer or solicitation for the sale of any financial product or service or a recommendation or determination by Sprott Global Resource Investments Ltd. that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on the objectives of the investor, financial situation, investment horizon, and their particular needs. This information is not intended to provide financial, tax, legal, accounting or other professional advice since such advice always requires consideration of individual circumstances. The products discussed herein are not insured by the FDIC or any other governmental agency, are subject to risks, including a possible loss of the principal amount invested.

Generally, natural resources investments are more volatile on a daily basis and have higher headline risk than other sectors as they tend to be more sensitive to economic data, political and regulatory events as well as underlying commodity prices. Natural resource investments are influenced by the price of underlying commodities like oil, gas, metals, coal, etc.; several of which trade on various exchanges and have price fluctuations based on short-term dynamics partly driven by demand/supply and also by investment flows. Natural resource investments tend to react more sensitively to global events and economic data than other sectors, whether it is a natural disaster like an earthquake, political upheaval in the Middle East or release of employment data in the U.S. Low priced securities can be very risky and may result in the loss of part or all of your investment. Because of significant volatility, large dealer spreads and very limited market liquidity, typically you will not be able to sell a low priced security immediately back to the dealer at the same price it sold the stock to you. In some cases, the stock may fall quickly in value. Investing in foreign markets may entail greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks. You should carefully consider whether trading in low priced and international securities is suitable for you in light of your circumstances and financial resources. Past performance is no guarantee of future returns. Sprott Global, entities that it controls, family,


Shree Kargutkar
Shree Kargutkar
Portfolio Manager
Sprott Asset Management LP

Sprott Asset Management LP is the sub-advisor for Sprott Gold and Precious Minerals Fund and Sprott Silver Equities Class.
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