The trifecta for gold is in place but are investors prepared?
The Trifecta For Gold
December 19 (King World News) – Otavio Costa: It’s time for a comprehensive analysis of the overall (gold & mining) thesis.
Let’s start with the macro part first.
The ultimate supporting thesis to invest in the mining industry boils down to what we call the “Trifecta of Macro Imbalances”:
* Excessive debt-to-GDP levels
* Highly elevated inflation rates
* Financial assets at near record valuations
These economic issues necessitate a financially repressed environment where the cost of capital must remain lower than inflation, even in a structurally higher interest rate environment.
As a result, in our strong view, all roads eventually lead to gold.
The next chart illustrates one of the most important new secular theses in global macro today.
Central banks have been anything but shy in accumulating gold recently.
After forming a 20-year base, we are seeing the early signs of an upward move in gold holdings as a component of foreign reserves in relation to US Treasuries, German Bunds, UK Gilts, and JGBs.
Central Banks Keep Buying Large Quantities Of Gold
Unsustainable debt-to-GDP imbalances worldwide, portend ongoing devaluation pressure on fiat currencies.
Sovereign debt is becoming less and less attractive while gold’s appeal as a monetary metal is rising.
Central banks must consider the composition of their FX reserves in supporting the stability of their respective monetary systems.
This is setting the stage for gold to reemerge as a key asset in improving the credibility of central banks’ balance sheets…
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Rising geopolitical tensions only add to this thesis with gold being the perfect neutral alternative.
Now, it’s time to understand the overall cyclicality of gold and silver companies.
Tracking the fundamental changes in the mining industry is one of the most reliable ways to identify what stage of the gold cycle we are in.
Measuring the level of activity of M&A transactions is one example.
Companies normally go on a buying spree at the peak of the gold market and, conversely, they tend to do the complete opposite near market bottoms.
While we have seen the start of some transactions recently, the aggregate value is nowhere close to what we saw at the late stages of the prior cycle.
Nonetheless, it is important to note how miners continue to generate near-record levels of cash flows today.
Acquisition Spree Should Soon Kickoff
The strength of the balance sheets of mining companies is an important factor that tends to precede healthy M&A cycles.
As shown in the chart below, the largest gold and silver companies have the highest cash levels that we have seen in decades.
Highest Cash Levels In History For Gold & Silver Miners
Additionally, precious metals mining companies just went through a long deleveraging process.
In other words, the industry had seven years of continuous debt repayment, net of new issuances.
This is a very healthy development for miners overall.
In such a capital-intensive industry where resource projects can take decades to be developed:
The capex cycle of these businesses can be critical in understanding the long-term supply and demand dynamics of metals.
Aggregate capex as a percentage of cash flows has been in a secular declining trend since the GFC.
Even though mining companies have become more profitable over the years, they have been gradually decreasing the amount of capital that they re-invest in their businesses.
This Will Significantly Exacerbate The Looming Gold Production Cliff
Furthermore, exploration budgets continue to be slashed as large mining companies have severely underinvested in greenfield projects.
Management teams have been focused on tapping existing reserves to generate cash flow to run their businesses rather than future growth.
This scenario has set the stage for a supply cliff among the majors.
They have left themselves with no other choice but to acquire deposits from outside to replenish their mineral resources.
Gold Supply Cliff Will Eventually Send Gold Into A Mania That Dwarfs The 1970s Bull Market
Therefore, when the metals’ markets firm, the majors and mid-tiers will be tripping over each other in the M&A markets to acquire the limited new large, high-grade deposits.
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