Image courtesy of World Gold Council

Gold’s fire was burning brightly before the novel coronavirus outbreak, appreciating 18.4% in US dollar terms in 2019, but the COVID-19 pandemic has doused this fire with fuel, as the world begins to grasp the true extent of the economic fallout that lies in its path.

The World Gold Council’s (WGC) Gold Outlook report from January 2020 predicted that the interplay between market risk and economic growth would drive demand for gold in 2020, with strong investment demand somewhat offset by a relatively weak consumer market. “Since the coronavirus struck, these trends have continued and been amplified,” observed John Reade, WGC’s chief market strategist, relating that investors have bought gold to protect themselves or profit from the impact of the pandemic, while consumer markets have been weakened or even closed due to lockdown regulations, and central banks have continued to buy gold, albeit at a slower pace than before.

Incrementum’s In Gold we Trust report of May 27th, now on its 14th edition, is titled ‘The Dawning of a Golden Decade’ – an accurate reflection of current industry sentiment. Affirming that it is only a matter of time before we see new all-time highs for gold, the report states: “The question is not whether the gold price will reach new all-time highs, but how high these will be.”

“I cannot remember the last time I felt such strong convictions,” enthused Keith Spence, president and CEO of Toronto-based investment firm Global Mining Capital Corp. “Even in 2008 in the wake of the financial crisis, the climate for gold was not quite as optimistic as it is now,” he said, suggesting that all the attributes for a sustained bull run with significantly higher gold prices are now lined up.

What are these attributes? Firstly, gold is a natural hedge for both inflation and deflation. With interest rates near zero in the US and negative in some parts of Europe, currencies are not paying the interest that previously gave them an advantage over gold. After the devaluation of the Euro, the Pound Sterling and the Yen, the last ‘flight to safety’ currency appears to be the US dollar. During the mid-March liquidity crunch, as stocks were sold off en masse (and gold stocks were no exception), investors did indeed flock to the dollar. However, the trillions printed by the US federal reserve in pandemic relief is bound to debase and devalue the currency. Government interventions have been necessary, but will overstretch the debt sustainability of many countries.

Geopolitical tensions are also stoking the fire, as trade tariffs and protectionism have spiraled into accusations of culpability between Western powers and China. “Even before the coronavirus outbreak, we had noticed escalating tensions, and the current context has inflamed the situation,” noted Spence, who works with both Chinese and North American investors between Global Mining Capital’s offices in Toronto and Beijing.

Future gold supply is another factor, with majors favoring an M&A approach to increase reserves in recent years. Limited large-scale exploration success in the past decade is correlated to a downtrodden junior community struggling to raise capital as the excesses of the previous super-cycle turned investment dollars away from the industry. While the rising gold price should see exploration budgets increase in the second half of 2020, juniors will be making up for time lost during lockdown.

From an investment standpoint, the traditional alternatives to gold do not appear to offer stability. Expanding balance sheets and the government monetization of debt will devalue bonds; credit instruments such as corporate bonds will be impacted by waves of bankruptcies; commercial real estate will suffer as populations continue to work from home; and US equities will struggle in the overdue recession. “It is circumstances like these that put gold onto the radar of those that have not invested in it before, or have not invested recently,” stated Reade.

Increasing investor appetite makes up for weak consumer demand

The WGC’s monthly commentary from July 7th reported that the net inflows of gold exchange-traded funds (ETFs) closed H1 2020 at 734 tonnes (mt) (US$39.5 billion), outpacing records for any calendar year, in only six months. The North American and European markets have been particularly active, with North American instruments accounting for the lion’s share of the buying (80% of global net inflows in June). Within Europe, demand has remained healthy in traditional strongholds Switzerland and Germany, and the UK has seen an influx of activity from institutional and retail investors protecting themselves from the potential impacts of Brexit.

A peculiarity, however, has been the trend of big bullion banks pulling back from trading gold futures. Why is this happening? “This issue started off as a concern about logistics, and has transformed into an issue of risk-appetite amongst some of the banks,” explained Reade, who went on to elaborate on the series of events that transpired.

In March, the lockdown-induced closure of three of the four big gold refineries in Ticino, the Italian part of Switzerland, combined with the grounding of international air travel, led to a concern that gold would not be able to get from mine to refinery and then to delivery point for the futures market. This put the efficient operation of the over-the-counter Loco London gold market and the Comex gold futures market in New York in jeopardy, causing the relative price of the OTC in London and Comex in New York to become volatile, which resulted in big market-to-market losses for a number of banks.

Long London and short Comex, a staple banking activity due to its relatively risk-free nature (as it does not usually move around a lot and allows banks to connect the two markets together), suddenly became a risky play. “This loss may have been the final nail in the coffin prompting Scotiabank to leave the precious metals market, and it has made banks reluctant to have large mismatched positions,” commented Reade.

In parallel to volatility in the futures market, the pandemic sparked a round-the-clock rush to fill US gold vaults, with New York gold inventories seeing the biggest inflow on record in April and May, according to a Bloomberg report from May 29th. On May 28th, traders announced they would deliver 2.8 million ounces of gold against the June Comex contract, the largest daily delivery notice in data going back to 1994.

In one of the key consumer markets for gold, Indian jewelry demand was weakening even before the virus, according to Reade. “However, as certain states have come out of lockdown, such as Kerala (the top gold consumer in the country), there has been strong demand with shops reopening,” he observed.

The WGC expected robust demand for scrap coming back to the Indian market, with owners of gold who may have lost income looking to sell due to economic hardship, but as of June, this has not been the case. Furthermore, there has been a rise in borrowing money against jewelry or gold holdings – an important part of the Indian lending market. “Banks do not like to lend money unless it is collateralized or secured, and because Indian consumers often have a high proportion of their wealth in gold, this is a way they can raise money at a cost-effective basis,” explained Reade.

Looking further ahead on the demand side, the world’s largest jewelry maker by volume, Pandora, announced it would stop using mined gold and silver in its pieces starting in 2025. This sustainability initiative by the Danish jewelry maker, which said its shift to recycled supplies would cut carbon emissions by at least 66% for silver and more than 99% for gold, is a potential cause for concern for the mining community. It also adds weight to the growing importance of ESG considerations. In the not-too-distant future, sustainably-sourced gold may be a pre-requisite for many customers.

Does geopolitical tension still move the needle?

Historically, increases in geopolitical tension, particularly involving an oil supplier, would see people purchase gold. Indeed, the US killing of Qassem Soleimani and Iran's retaliatory strikes on US targets in Iraq contributed to a spike in the gold price from US$1,519 to US$1,571 in the first week of January. However, could the case be made that geopolitical tension has become such a norm in recent times that it no longer stokes the price of gold like it used to?

In the two months after gold broke the US$1,700 barrier on April 9th, the following happened: confirmed coronavirus deaths went from under 100,000 to over 400,000 globally; WTI oil became cheaper than toilet paper; president Trump terminated the US relationship with the World Health Organization; US Secretary of State Mike Pompeo claimed there was "enormous evidence" that the coronavirus originated from a Wuhan laboratory; China announced plans to impose a new security law on Hong Kong; and violent riots erupted in all 50 states of the US in reaction to the murder of George Floyd by a Minneapolis police officer. By Monday June 8th, spot gold was trading at less than US$1,700.

Why did the gold price fail to respond to the geopolitical turmoil from April to June? "If you look historically, gold moves high quickly then consolidates for a while as high-frequency speculators, who have ridden the price up, take some profits and test to see where the supported price is,” said Reade, a theory supported by gold’s ascent to the US$1,900 range in July. Furthermore, the remarkable rebound of US equities in the wake of the historic mid-March sell-off created numerous opportunities for investors in US stocks to “buy the dip”. In response to unprecedented fiscal support from central banks, this has created a chasm between stock market sentiment and the real economy.

What have we learned since the global financial crisis in 2008? Do not fight the fed. A whole generation of investors has been taught that the federal reserve will come in to support markets and economies if things look like they are going wrong. However, it is unlikely central banks will be able to shield economies from the impacts of the virus, particularly as new waves of redundancies come through when furlough schemes end. Talk of a sustained v-shaped recovery seems to be based on optimistic political rhetoric. Illustrating the potential scale of the recession, the IMF predicted the worst economic crisis since the Great Depression, with a cumulative loss estimate to global GDP of around US$9 trillion.

“When tensions return to preexisting levels, which they usually do after a short, sharp war, then gold comes off,” explained Reade, suggesting that this is not the greatest reason to be buying gold. While geopolitical tension will impact gold sentiment to some extent, the real reason to be bullish is the looming economic crisis. “Gold is much more a hedge of economic uncertainty than a geopolitical hedge,” he said.

Gold as a strategic asset

On May 20th, the Zambian government agreed to amend the Mines Act, classifying gold as a strategic metal to allow all citizens to benefit from its exploitation, according to Barnaby Mulenga, permanent secretary at Zambia’s Ministry of Mines. While this amendment still allows Zambia to grant gold mining licenses to foreigners, it is indicative of a wave of protectionist measures taken by developing nations to control gold supply in 2020.

In April, the government of Papua New Guinea (PNG) announced it would not extend the mining lease on the Porgera gold mine operated by Barrick, which contributes approximately 10% of the country’s exports. On June 24th, Barrick Niugini Ltd, which operates the mine as a joint venture between Barrick and China’s Zijin Mining Group Ltd, announced it will lay off most of its staff at Porgera, including 2,650 Papua New Guinea nationals. This signal that an impasse with the government over ownership is unlikely to be resolved swiftly was reinforced with the following statement: “The government had repeatedly refused to enter into meaningful discussions about the issue.”

While issues between Barrick and PNG continue to linger, the Toronto-based miner has recent history in successfully negotiating deals in other high-risk jurisdictions. In January, Barrick granted Tanzania a stake in three gold mines via the Twiga Minerals joint venture. “We are breaking new ground and pioneering the way we share the economics of mining with host countries in a developing world,” stated Bristow in his interview with Global Business Reports, advocating the role of mining as an “engine for economic transformation”.

The approach of sharing a greater proportion of wealth with host countries is commendable. However, as governments try to stimulate depressed economies in the wake of the pandemic, will the risk of nationalism make jurisdictional stability even more of an issue with investors? “The challenge I see coming is what countries are going to do to stimulate economies,” observed Wheaton Precious Metals’ (TSE: WPM) president and CEO, Randy Smallwood, who expects to see a trend towards nationalism as governments looks for ways to take a bigger piece of the pie. On the other hand, the drive to reestablish economic activity could help advance projects that have been in permitting limbo. “Profitable mining operations pay huge taxes, and this is a great way of kick-starting the economy without having to print currency,” added Smallwood.

Mining companies can also benefit from state-driven initiatives to guarantee gold supply. TSX-listed Steppe Gold made the transition from development to production on March 25th, announcing the commencement of ore processing at its ATO gold mine in Mongolia. On May 11th, Steppe reported its first sale of gold and silver to the Central Bank of Mongolia, generating cash flow before streaming obligations of US$8.5 million. “By selling in-country we pay a 5% flat government royalty, compared to the 10% royalty charged for exporting,” explained executive director Aneel Wairach, mentioning that for the next four to five years all of Steppe’s production will be sold to the Central Bank.

As gold rises in times of economic strife, the importance of sharing the vast wealth it creates should not be understated. “I believe that you mine a national asset,” said Bristow, stating that if a mining company does not fulfil its duty to deliver value to the host nation, the metal should be left in the ground. “The value of that asset should be divvied up into various segments, and most importantly back into the communities and the population of that country,” he added. This sentiment was echoed by Doug Ramshaw, who urged his peers to think about how they can pay forward the benefits the gold sector expects to receive in the coming years. “Gold sentiment has a very macabre nature to it, tending to do well when people are suffering in one way or another,” he reflected.

The onus to give back to the communities should not only fall on the shoulders of producers, suggested Smallwood. On April 20th, WPM announced the launch of a US$5 million Community Support and Response Fund to help combat COVID-19, incremental to the company’s Community Investment Program that provides support to over 50 programs in communities around the world. “In the 1990s, I had to make royalty payments on a regular basis, and always thought these royalty companies were getting a bit of a free ride,” revealed Smallwood, speaking of his background building and operating gold mines, and how it shaped his philosophy for Wheaton. “If we as a resource industry do not reinvest back into the communities around us, the industry does not have a life,” he concluded.