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Why Gold Must Go Higher

I welcome the views of the Sprott gold report, which suggests gold is on the cusp of breaking out to all-time highs in US dollars. It has already done so in virtually every other currency. Sprott also is of the view that gold mining stocks continue to lag the metal and, in their opinion, represent a compelling investment opportunity.

Based on current metal prices, most companies are generating positive earnings and cash flow that can be applied to higher dividend payouts. Compared to other sectors, the gold mining industry stands almost alone in looking forward to strong 2020 earnings and a positive 2021 outlook.

Sprott describes the COVID-19 pandemic panic as “merely the black swan that punctured a financial market asset bubble that took almost a decade to inflate.” The fiscal and monetary policy measures implemented by governments has created a debt hangover that will linger for years. Economic growth will rebound but only to subpar levels once extreme health-related restrictions are lifted and “stimulus” kicks in.

At gold’s previous peak in 2011, the combined balance sheets of the U.S. Federal Reserve and the European Central Bank totalled approximately US$5.5 trillion. Today, that number is more than $11.4 trillion and rapidly moving higher. The USD gold price is still lower than nine years ago. Therefore, the gold price is still well below where it should be and will likely trade higher in the new macro landscape.

Gold has done a fantastic job of holding its value during the COVID-19 pandemic and it should continue to do so as central banks flood the market with cheap money. But there are some longer-term factors that should help provide gold price support.

Firstly, developing new gold mines is expensive, time-consuming and risky. Therefore, many of the larger gold mining companies have adjusted their strategies to focus on producing the highest profit per ounce of gold produced, rather than producing as many ounces of gold as possible (as has been the industry’s practice in previous gold price booms). Hopefully, this will lead to better shareholder returns.

Take Barrick Gold for example. The senior gold miner has released its 2019 annual report, which includes its 10-year production targets. Notably, Barrick is not forecasting any growth at all over the next 10 years - it expects to produce 5 million of ounces of gold this year, and 5 million ounces by 2029. (Barrick's stock is up 42% YTD, compared to a 2.25% gain in the broader US Gold Index)

Newmont (NEM) has also provided similar guidance, the senior gold/copper miner says it will produce approximately 6.7 million ounces for 2020, while it's forecasting production to be between 6.5 -7.0 ounces through 2024. Newmont has been one of the sector's biggest winners, returning 36.32% YTD.

The lack of new gold supply is contributing to ‘peak gold’, meaning that gold mine supply reached its peak level in 2019, based on current forecasts. According to Barrick’s estimates, we're likely going to see a rapid decline in gold supply starting as early as 2022, as there are very few new, large scale gold projects coming into production anytime soon.

There are just not that many top projects out there, and gold miners have been putting less new projects into production. Projects that carry high upfront capex are being put on the back burner or shelved entirely, as miners focus on maximizing profits and deleveraging by using cash to pay down debt.

According to the World Gold Council, total mine production was 111.3 million ounces in 2019, down slightly from 112.8 million ounces in 2018. Output has been significantly impacted in Q1 from COVID-19 closures but was already set to decline through 2020, according to BMO Capital Markets.