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General Market Commentary
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General Precious Metals
The Sweet Spot for Gold Equities
Gold gained $40.56 to close the month at $1,513, a gain of 2.75%. YTD gold is up 17.97% as of 10/31/19. Silver bullion rose 6.55% for the month, and has gained 16.86% YTD as of 10/31/19. Gold equities gained 5.25% for the month, and are up 37.81% YTD as measured by Sprott Gold Miners ETF (SGDM).
Gold Bullion Consolidates in October and Closes Higher on Rate Cut
October was another consolidation month for gold bullion. Gold traded in a narrow $33/oz range dictated mainly by the action of global bond yields. Gold held above our support level of $1,450 and consolidated within a bullish wedge pattern. From a positioning view, Commodity Futures Trading Commission (CFTC) longs had a minor pullback. CFTC shorts remained unchanged while ETF holdings continued their gradual accumulation. Since the gold price peak in early September, there has been an uneven nascent risk-on short-term basing action in some parts of the capital markets. The October 30 Federal Open Market Committee (FOMC) meeting resulted in the expected 25 basis point cut in interest rates and a signal from the Fed that future rate cuts may be on hold, representing more of a “pause-lite” rather than an “absolute pause.” With the “Fed put” reaffirmed, the U.S. stock market rallied to new all-time highs, yields declined, the U.S. dollar fell and gold closed higher on the day.
Month of October 2019
| Indicator | 10/31/19 | 9/30/19 | Change | % Chg | Analysis |
| Gold Bullion | $1,513 | $1,472 | $40.56 | 2.75% | Consolidating in short-term range, before rise |
| Silver Bullion | $18.11 | $17.00 | $1.11 | 6.55% | $17 base held, carving out base |
| Gold Equities (SGDM)1 | $24.13 | $22.90 | $1.23 | 5.25% | Breaking out from a consolidation flag |
| DXY US Dollar Index2 | 97.32 | 99.38 | (2.06) | (2.1)% | Testing bottom of rising trend |
| U.S. Treasury 10 YR Yield | 1.69% | 1.66% | 0.03% | 1.6% | Consolidating in short-term range |
| German Bund 10 YR Yield | (0.41)% | (0.57)% | 0.1% | 28.07% | Consolidating, major downtrend in place |
| U.S. 10 YR Real Yield | 0.14% | 0.14% | (0.00)% | (0.00)% | Consolidating in short-term range |
| Total Negative Debt ($Trillion) | $12.80 | $14.76 | ($1.93) | (13.1)% | Pullback inline with yields |
| CFTC Gold Non-Comm Net Position3 and ETFs (Millions of Oz) | 111.20 | 116.90 | (5.67) | (4.9)% | Pullback in CFTC longs only |
We believe that the recent injection of liquidity has continued to inflate asset prices. The S&P 500 Index has made new highs despite weakening global growth, an earnings slowdown and funding stress. By contrast, global bonds continued to trade near highs as signs of economic weakness abound. The 5Y/5Y inflation swaps for both the U.S. and EU remain subdued with a long-term downtrend solidly in place. The EU 5Y/5Y touched all-time lows in October despite the launch of quantitative easing (QE) by the European Central Bank (ECB). Credit stress remains subdued, likely due to the massive liquidity injections in the repo market, although LIBOR-OIS (London interbank offered rate-overnight indexed swaps) spreads remain elevated in line with the condition of the repo market. Commodities continued to struggle as demand remained weak. Gold bullion, by contrast, still has a very constructive outlook in the medium- and long-term.
Figure 1. Gold Bullion is Consolidating Below the Last Significant Resistance Level Before a Re-Test of Previous Highs
Source: Bloomberg as of October 31, 2019.
Gold Equity Earnings About to Surge
Gold companies will be announcing Q3 earnings shortly with the majority reporting in the first week of November. We mentioned in our prior commentaries that the increase in gold pricing would be reflected in gold companies’ earnings materially. The average price of gold bullion in Q3 was $1,474/oz, which is 12.6% higher than the Q2 average of $1,309/oz. Using the World Gold Council’s data on gold production costs, the industry has roughly an all-in-sustaining-cost (AISC) of $900/oz.
Here we take a stab at estimating the impact of the higher gold price on gold producers’ profits. We are assuming that the Q3 industry AISC is likely to remain unchanged at $900/oz as the main component costs of labor and energy remained subdued.
- The Q3 average gold price of $1,475/oz less industry AISC of $900/oz = $575/oz profit (40% higher)
- The Q2 average gold price of $1,310/oz less industry AISC of $900/oz = $410/oz profit.
Q3 over Q2 profits, in general, should increase about $165/oz or 40% higher based on the 12.6% gold price increase. This quarter-over-quarter increase is materially higher than any industry that we have scanned. The operating leverage in profit increase also helps illustrate why historically gold equities typically have a 2x to 3x leverage to gold prices. High-cost producers will benefit even more as their leverage to the change in the gold price is much higher. If we use a higher cost Q3 AISC of $1,000/oz in this example, the Q3 profit will be $475/oz versus Q2 profit of $310, or 53% higher.
We're in the Sweet Spot for Gold Mining Company Earnings
There are also indications that gold company Q3 earnings may enjoy an additional positive earnings surprise. According to Bloomberg, the consensus gold price deck used by analysts for Q3 earnings estimates was $1,430/oz versus a realized gold price of $1,474/oz. A quick calculation indicates a potential 10% earnings per share (EPS) surprise based on the difference between the lower price deck used and the realized gold price. At this stage in the gold cycle, we are in the sweet spot for gold mining company earnings. A starting low gold price base will result in earnings changes with a high percentage increase when measured quarter-over-quarter or year-over-year. Expectations are very muted after years of disappointment, and the probability of earning surprises is higher. Lastly, other major market sectors are predicted to experience modest earnings expectations making comparisons to gold company earnings quite dramatic.