Gold: America’s Forever War Is Not Over

October 8, 2021

President Biden’s messy departure from Afghanistan has long reaching consequences casting a long shadow over his domestic plans into the upcoming midterms. For one thing, he dug himself a deeper hole when he vowed to conduct operations against ISIS-K. After the Afghan debacle, this forever war is forever. For another, in an attempt to cobble a common front against China, Biden signed a military pact with the U.K and Australia (AUKUS) leaving other allies out in the cold, particularly France, who is now leading a “Europe First” strategy. America has simply lost the trust and primacy once enjoyed in international affairs. America’s defeat from Afghanistan is not the end of an era but unfortunately a reminder of the futility of the oft repeated cycle of occupation and withdrawal. Already Iran, Russia and China have challenged America with growing success, jumping into the vacuum left by the messy exit as the geopolitical order changes. Yet, look more closely, the message is that democratic government today is about competency. America’s defeat raises questions or concerns about America’s global primacy. The malaise of America comes from within. Less obvious is the policy failures of government and Biden’s own competency from a stalled legislative package to government funding and now a debt impasse than will hurt next year’s midterm election where they are likely to lose their razor thin majority.

To many observers, America’s deeply schizophrenic behaviour is worrisome in that they seem incapable of consistent, competent policy from tackling migration, to geopolitics to climate change and to COVID-19. In control of two branches of government, Mr. Biden pledged to restore the potency of American government. Unfortunately, these days are seen through the lens of partisan politics and splits within his own party threaten to sink his ambitious social agenda. America it seems is in decline, losing stability at home (last election) and abroad (Iraq and now Afghanistan). Life and death issues like the pandemic, are being kicked well down the road. The Biden administration was to usher in a new era, He didn’t.

America’s Allies Left Out in the Cold

The global ramifications are significant. America’s allies too are confused, questioning whether Mr. Biden is just a tamer version of Donald Trump. Without consultation, Mr. Biden left his NATO allies stranded in Afghanistan and even rebuffed requests for an extension to allow them to extricate their people. Again, without consulting his allies of Quad (India, Japan, Australia, US) or Five Eyes (Australia, Canada, New Zealand, US and UK), he inked AUKUS, a military pact with the UK and Australia. The move pushed aside France’s strategic alliance in Indo-Pacific, killed their submarine deal with Australia and undermined US diplomatic relations in Europe.

On Sino-American geopolitical relations there seems to be little substance or change from Trump’s trade war, hardline rhetoric, or sanctions. President Biden has altered the Indo-Pacific geopolitics such that staunch ally India now has to deal with a Taliban-governed Afghanistan who has lined up with Pakistan, paving the way for China to again isolate India further. Trade, once a central plank of American democracy has broken down as America’s growing protectionist stance undermines global integration. Despite rising Chinese trade surpluses, President Biden has maintained tariffs on $350 billion of Chinese goods, which has hurt US consumers and manufacturers with higher prices and broken supply chains. Ironically, while Americans created a new trilateral defense pact, that same week China applied to join the successor to the “Trans-Pacific” Partnership (TPP), a trade pact designed by Obama to limit Chinese influence in the region, but abandoned by Donald Trump in 2017. Every time the US uses its hegemon, it encourages the world to look for alternatives to counter its dominance. Either way there is a cost.

Mr. Biden’s “Carter” moment may be temporary, if he could deliver on other fronts, such as the economy. But can he? While the global economy has recovered led by China, the Delta variant has slowed the US economy while consumer prices skyrocketed to the highest in 10 years, easily surpassing the Fed’s target, raising fears of runaway inflation. And, despite hopes of a transitory climb, shortages of parts and labour, blocked ports and disrupted supply chains have more broadly created uncertainty, coinciding with the American rebound from the pandemic. Inflation is to become our universal problem.

Trump “Lite”

Donald Trump was polarizing, acting as a steam roller to make “America Great” again. Lawyers behind Donald Trump’s attempt to overturn the 2020 presidential election were rebuked by various courts to date. In the lawsuit to overturn Michigan’s 2020 election, US District Court Judge Linda Parker said, “the case was never about fraud, it was about undermining the people’s faith in our democracy and debasing the judicial powers to do so”. Earlier Rudy Giuliani, former mayor of New York and advisor to Trump was banned from practicing law for his part in the election, cited for “false and misleading statements”. Still, Mr. Trump and a good part of the US electorate believe the election was stolen. The midterms are looming in a divided state of America.

Of longer consequence is not the return of Trump or an acolyte in 2024, but that Trump’s four years ushered in a period of rising populism, protectionism and, prejudice which like COVID has infected the world. To be sure, Biden botched the Afghan exit but like his predecessor’s single-minded intention, left America’s allies and, worse did not even seem to care or shoulder the responsibility. And, like the president before him, he ignored the experts. On domestic policy, Mr. Biden is not only building another wall but his immigration policy and border round-up outdid Mr. Trump. As such, the deterioration in trust has spread globally in America’s leadership.

American history shows that before the retreat from Afghanistan there was a string of interventions in Korea and Vietnam followed by Iraq, Libya and Kuwait. While the era of American proxy wars seems to be fading because so many of these interventions ended badly, the common denominator is that wars cost money. Afghanistan’s price tab alone was $2 trillion. History is full of countries that lost to challengers leaving behind big debts.

Only time will tell whether America’s Afghan defeat coincided with the end of the American empire, mirroring Great Britain’s near bankruptcy, that cost its preeminent position in the world. At one time, Great Britain was the global centre of finance and exported 40 percent of all exports but its hegemony was squandered by the first and second world war debts. As a result, British sterling was replaced by the US dollar as America became Britain’s creditor and beholden to the US, the dollar became the world’s reserve currency, backed by gold. Today, China has become the largest creditor in the world, whilst America has become the largest debtor. America’s primacy is not forever.

Today, with rocky China-US relations, the resolution of Meng’s three-year battle with US and Canada is a positive step in the larger rivalry paradigm. However, we believe the US is falling into the Thucydides’ Trap which describes how in 12 of 16 times, when an incumbent country was challenged by a competitor country, the end result was bloodshed. The irony is that the most powerful US institution in Afghanistan was not its military but the Treasury Department which froze some $9 billion of Afghanistan’s international reserves. Since America’s wars have been financed largely by debt, the never-ending fear is of a repeat of what happened to Great Britain.

Inflation is Back

We believe America’s government-supported recovery is at risk with their debt skyrocketing to 110 percent of GDP, in part because the government finances are stretched after spending a mammoth 15 percent of GDP to prevent the pandemic crisis from becoming a financial crisis, according to recent IMF data. Meantime, government spending, thanks to the pandemic rose 34 percent with the government financing or monetizing that debt and there is no credible plan to get out of this debt trap. Never in history has there been so much money spent in so short a time, dwarfing the money spent after the last global financial crisis in 2008.

A look back at history shows that rising inflation can easily morph into hyperinflation. Lessons can be learned from the way hyperinflation developed in Germany, Austria, Hungary or Venezuela today. The common denominators?

 Reckless fiscal policy

 Deficit spending as each country ran enormous budget deficit financed by themselves.

 Double digit then triple digit increases in money supply.

 Government financed debt.

The United States has ticked off all the boxes. Money supply has grown 33 percent over a two-year period. The Fed has bought and monetized almost half of the public offerings in circuitous fashion. Although, US inflation at 5.4 percent is nowhere near hyperinflation levels, US producer prices increased solidly in August for the biggest gain in 11 years, suggesting that inflation will persist. In fact, the bubble-prone Fed is happy that inflation has exceeded their own targets believing that the uptick is transitory and will return to the Fed’s 2 percent target. Yet, they shouldn’t be celebrating too soon.

Greenflation: Greening the Economy Will be Inflationary

The shin bone is connected to the knee bone, connected to the … so goes the song “Dem Bones”. That song also describes the UK energy crisis where the shortage of carbon dioxide and a confluence of factors are ironically contributing to a food, gas, and labour crisis leading to higher inflation. Also inflationary is the global push to lower carbon emissions and adoption of “cleaner” sources of energy that has hampered commodity production, pushing up prices for everything from natural gas, aluminum and food, exacerbated by Brexit shortages. We can’t lower emissions and subsidize fossil at the same time, without a cost.

The UK government is scrambling because of rocketing wholesale natural gas prices due to low storage facilities that squeezed supplies, driving up electricity prices, leaving consumers facing massive home heating bills and a dozen bankrupt energy wholesalers. As a result, heavy users like the large fertilizer plants were forced to close. The fertilizer plants make ammonium nitrate from natural gas and the halt in production of fertilizer resulted in a shortage of carbon dioxide which is a by-product, used to stun animals before slaughter and in hospitals for minor surgeries. The CO2 shortage has put meat suppliers out of business and the high energy prices have even affected steel plants. the subsidisation of the market resulted in government borrowings in August reaching the second highest ever.

Ironically energy inflation led by the soaring price of natural gas has become a global phenomenon leading to supply shocks and increased demand in India, China, and Europe. The spike in the cost of natural gas is particularly inconvenient for governments trying to decarbonize their economies (coal, oil and natural gas still makes up 80 percent of our global energy mix) and it did not help that Britain phased out most of its coal-fired power stations. Like the Seventies, everything is interconnected, the shin bone is connected….

Greenflation’s Unintended Consequences

Our interconnected world is heading into a global energy crunch and a bleak winter, which will reinforce inflation’s upward push. According to the IEA, 81 precent of the world’s energy supply still comes from fossil fuels. Coal, carbon and European gas prices hit record highs as crude oil surged beyond $80 a barrel or the first time in 7 years. German inflation is at 29-year highs. Less drilling, government-imposed cutbacks on emissions and the global pandemic bounce resulted in a rebound in demand at a time when the industry is trying to replenish low supplies. Natural gas has increased five-fold. China too is grappling with a power shortage because much if its electricity is generated using coal that could damage the broader economy. COVID-19 continues to ravage supply chains, driving up shipping costs and prices.

During the past decade, Europe shutdown hundreds of coal plants to curb energy consumption and carbon emissions. Meantime, governments have spent trillions in handouts to renewable industries like wind and solar power, yet renewable energy has not replaced the shutdown in capacity, resulting in the shortages and high prices today. In addition, a pick-up in demand post pandemic also pushed up prices. Coal itself has tripled in price. And, to combat climate change, Europe’s cap-and-trade initiative pushed prices higher as the price of credits spiked because of the threat of government-imposed carbon taxes. The “greenflation” factors are reshaping the energy sector from a cyclical to a structural bull market.

A Recipe for Higher Inflation

The energy shortages in China also mirrored tight supplies in Europe as the economy post-pandemic caused a surge in energy consumption, exacerbated by reduced supplies due to the “green” industrial revolution. About 70 percent of China’s electricity generation is based on coal and the government’s edict have led to shortages, that were not replaced by renewables. China is facing power shortages due to its toughened regulations, which has resulted in shortages of coal supplies pushing energy prices higher causing the government to order energy companies to secure winter supplies “at all costs”. The power crunch also forced the rationing of electricity, affecting over 20 provinces as the country had to shutdown key downstream sectors, such as steel, aluminum and cement. Cheap energy has become part of the past. China’s energy problems have triggered a surge in food and agriculture prices as shutdowns and difficult harvests boost demand for corn, soy, wheat and cotton.

Italy has spent $1 billion in handouts to reduce consumer gas prices because more than two-thirds of their energy needs are imported. Italy has unveiled plans for a multibillion package because of fears of an energy squeeze after gas prices soared in Europe. The inflationary increase is being felt across the board as Europe faces a shortage due in part to lower storage capacity and tighter supplies from Russia, ahead of the start-up of the controversial NordStream 2 pipeline that bypasses the Ukraine. Soaring global energy prices are not transitory and the OECD expects that higher energy and wages prices will put upward pressure on prices for the next two years. As a consequence, the International Energy Agency (IEA) has urged Russia to increase supplies to Europe beyond contractual amounts to alleviate the energy crisis. The irony is that all the world is coming together in Scotland for the UN Climate Summit at COP 26, pledging to reduce emissions by shutting down hydrocarbon energy, yet these same countries are subsidizing the usage. Climate change will be very costly.

An End to Cheap Money?

Meantime the Fed’s excess liquidity continues to stoke the inflationary fires with the Fed continuing to buy $80 billion of Treasuries and $40 billion of mortgage-backed securities every month, adding to the gargantuan $8.3 trillion balance sheet, equivalent to almost half of the US economy. The Fed has spent the last decade combining monetary and fiscal policy using what was once experimental, quantitative easing to finance the government’s profligacy, ignoring the consequences of the resultant asset bubbles. That largesse of government flooded the market with newly created cash paid with a digital “click”, which has propped up stock prices through dividends and share buybacks. However, since future rates are likely to be higher than lower, as short rates inevitably move up, the interest bill will rise significantly, possibly quadrupling the current $500 billion interest bill – that is America’s Achilles heel.

6 When the Fed purchases Treasuries, it pays with money created by itself. Fuelled by the Fed’s ultra-loose monetary policy, this tsunami of cheap money has gone into the stock market, banks’ balance sheet, crypto and even helped finance that new Bronco or Corvette. Asset owners have also benefitted from cheap capital. Investors seem not too concerned. The Dow Jones is 20 percent above pre-pandemic levels. The technology driven Nasdaq is up almost 12 precent. Too much money chased too few goods.

Yet, the inflation outlook is ugly with pandemic related shortages for computer chips to coal supposed to be resolved by now. Instead, manufacturers are caught in broken supply chains, broadening out inflation. The rising cost of commodities also poses problems for the manufacturers who are also struggling with scarce labour, logistical problems and even the semiconductor shortages pushed up inflation. Although inflation has easily exceeded the Fed’s target, the Fed’s continuing purchases has caused the financial markets to overheat, stirring up trouble. No wonder we have the biggest asset bubble in US history.

Déjà vu

While the Fed is not yet ready to cut back on the trillions of dollars of monetary stimulus, the Fed has expanded what was once a temporary facility, the overnight Reverse Repurchase (RRPs) facility for overnight surpluses. The Repo facility was a swap arrangement designed for the Fed to offer Treasuries overnight in exchange for cash and the deal is reversed the next day, paying nominal rates of interest. However, for the money market player, the income though low was a money earner and, safe. Consequently, in the past month, the Repo facility had more than $1.6 trillion parked overnight, doubling the current participation to 70 institutions. Simply after 13 years of easy money, the Fed has “institutionalized” risk, making permanent its role. We believe that the Fed’s financial plumbing is clogging up, never a good sign.

All this points to the recent talk of an ‘exit strategy” or normalisation, which has investors rightly worried. Why? In 2015, rates went up and the market swooned. In the first quarter of this year, the 10-year Treasury yield rose by 80 basis points, reaching 1.74 percent and the market tanked. Today 10-year yields are up from 1.30 percent to 1.51 percent and “tapering” rhetoric alone has spooked the market giving rise to the shock the Fed is trying to avoid. Inflation and interest rates tend to move together. Today there is upward pressure on both as investors dump bonds on tightening fears. Yet, the Fed continues to purchase the same level of monthly asset purchases ($120 billion) as at the height of the COVID-19 outbreak a year and half ago. Worse, the Fed’s silence on rising inflation and the excesses in asset markets is breeding complacency similar to what happened in the Seventies. Déjà vu.

Risk and Rewards in China.

On China, Mr. Biden has escalated the Cold War despite the interdependence of our economies. Rather than rejoin the Trans Pacific Partnership, Mr. Biden created a submarine defense pact with the UK and Australia to counter China’s navy, which is now the world’s largest. While the US risks decoupling from its largest trading partner, Australia will have submarines.

And now, after three decades of firing up the capitalist engine and focussing on an export-led government, Beijing is pulling its economic interests away from America as Washington takes an increasingly hawkish stance towards China. The rapid growth of an industrialized China has created global iconic corporate behemoths but it appears that China has downshifted growth as part of a change in priorities. The world’s second largest economy has launched a volley of regulation changes, reigning in the big behemoths, overhauling technology, education, healthcare and housing sectors. The harsh intervention is an effort to make China a fairer and more productive country, and make its national champions toe the government line. China even hopes to inject greater discipline with stricter rules on borrowing, deleveraging the economy. Left unsaid is that one of the main reasons for the government’s Calvinistic crackdown is a move to close the “wealth gap” which has widened during the pandemic by using some of those capitalist profits to boost social justice. Unlike the West, the Chinese view capitalism and profits as a means to end, rather than the goal itself. Also, the regulatory clampdown is a tool used to boost competition and reduce systemic risk. Despite being a major participant in the market economy. China is also seeking to boost self-reliance in natural resources, technology and finance. Regulatory Crackdown, an Opportunity? For example, the $120 billion private education business was brought down a peg to equalise educational opportunities in the wake of runaway growth in private schools. China’s tech giants must now allow government access to precious data, leveling the playing field. Small and innovative companies have been given room to grow. The toughened regulatory action on finance forced some of the state-owned corporate giants to repatriate funds. In order to avoid an Archegos or Lehman moment, the government has been tackling the high levels of consumer and corporate debt as part of its changing priorities imposing “three red lines” to curb excessive leverage. Evergrande and Huarong, two giants that together owe half a trillion dollars were once part of the central engine of China’s economy, now risks default on their obligations. China’s pivot is also part of a social initiative to relieve the cost of living, and make the rich pay. Some have obliged with Chinese tech giants Alibaba and Tencent pledging to spend tens of billions for economic, job creation and social welfare by 2025 in support of Beijing’s new social contract, aka “spread the wealth”. As a side note, the policies initially appear draconian, especially when viewed through Western lens. However, Western governments too are pursuing the fat cat banking sector, big data and drug behemoths, which are in the crosshairs of policymakers. The Biden government wants the rich to pay too for his $3.5 trillion of social spending, but the culture wars have increased the cost and partisan politics will likely stall his ambitious plans. On the other hand, China has also ambitiously addressed one of the world’s most vulnerable sector, real estate. The world has enjoyed a housing boom fueled by historically low global interest rates. In China, housing makes up three-quarters of household wealth and about 29 percent of GDP. However, the world’s most indebted real estate player, Evergrande with over $300 billion of liabilities has been in trouble for years, which allowed officials to orchestrate an orderly restructuring. And rather than kick the can down the road and face the consequence of too much debt, China instead forced developers to take the hit with its tycoons taking on the role of bad guys. Yet complicating China’s image is that despite these reforms, China remains one of the fastest growing countries with its growing middle-class, exceeding that of America. Today, China represents about one third of global GDP growth and almost half of global investment. China has a dominating grip on global commodity markets and the biggest trading partner of most countries. Europe and Asia have deep economic ties to China, both as an export market and supplier. The UK government is the exception as London and Beijing trade barbs over Hong Kong and infrastructure investment. While western governments believe China has reverted back to anti-

8 capitalist, it continues to steadily develop its capital markets, opening up its financial markets with an intent of developing its large retail dominated market into a more integrated model with the Stock Connect schemes linking China and Hong Kong or Shanghai and London markets. As part of its “common prosperity” goals, China’s plans a new Beijing stock exchange (BSE) to support the funding of small and medium sized businesses as a complement to the Shanghai Stock Exchange, STAR market and ChiNext, a Nasdaq-like subsidiary of the Shenzhen Stock Exchange. Almost 87 percent of employment is in private companies. In developing its onshore capital markets, China hopes to lessen its dependence on Wall Street.

In Debt We Trust

The most worrying aspect about the rivalry between China and the United States is that like China, the United States is inordinately dependant on debt. But no one here seems to care about the inexorably rising debt levels. Like China, the US economy was boosted by a debt-fueled property market as the pandemic, home buying and consumption binge put Americans deeply into debt. Investors seemed to go from deal to risky deal looking for places to park their cash because benchmark interest rates are near zero. This surge in public and private debt to record levels during the recovery and the recent building of inflationary pressures raises question whether the greatest monetary loosening can be unwound without doing great harm to the economy.

To be sure, the seeds of the next financial crisis have been planted. Complacency has become endemic. Today, investors who purchase US debt trust that the liability is backed by the “full faith and credit” of the United States and that they will honour their obligations. However, amid this complacency, the debt ceiling discussions which are a result of America’s penchant to finance themselves with debt, has become like every other issue overly politicized, ritualized and subject to whomever is in power. The trust deficit with America seems to be growing by the day. The longer Congress fiddles holding the market and dollar as hostage, the more challenging for an agreement. The stakes are high. America’s credit rating was downgraded in 2011 amid a previous debt ceiling impasse and the last one actually stopped government from working. Despite a sorry record of raising the debt ceiling some 78 times since 1960, the US is playing with fire, just to make political points.

Debt Ceiling Cracking

Although extended to December, the United States will run out of money because the debt ceiling breach prohibits new borrowing above the existing $28.5 trillion debt level. The Democrats’ current razor-thin majority in both Houses is not enough to end the stalemate because some of Biden’s own Democrats are balking at passing Biden’s ambitious $3.5 trillion social spending package, which not only violated the debt limit but passed without one Republican voting for the budget. In a game of chicken, the Republicans have also threatened to block a debt ceiling increase. As the impasse widens, the US will have to address the debt itself and that is a tall order for the co-authors of that debt so polarized. With a rising death toll from the Delta variant, Mr. Biden’s popularity is sinking amid an ambitious social spending spree such that there are doubts over the direction he is taking the country. America keeps hollowing out its democracy at home, chipping away its credibility and with their patchwork health system, the debt showdown and fears of yet another dysfunctional government on Capital Hill, investors are concerned that a “game of chicken” could precipitate a global crash, unthinkable a year earlier. It has happened before. The last time the US defaulted on its debt was when Richard Nixon took the dollar off the gold standard in 1971. Gold was roughly US$35 an ounce then.

9 Investors would be wise to keep this in mind. Recent history shows that confidence in the economy and dollar can move together. There are two sides of the same sentiment coin. What is ahead is that despite a stronger economy with rising inflation, the risk is that investors concerned about America’s fiscal profligacy and its diminished international reputation will dump the greenback, which would reverse the trend and sink a vulnerable stock market.

The global economy is not in great shape. Risk is rising around the world. Gold has been stuck in a trading range losing 7 percent this year but we believe will mirror any decline in investor sentiment. We also believe that the viscous spike in consumer costs is also a warning of shrinking credit availability. By delaying tapering, the Federal Reserve is likely to add further froth to our asset and credit markets. The most liquid Treasury market for example is illiquid today. A government shutdown or disruption in the Treasury market would have a disruptive ripple effect in the largest market in the world, the derivative market. What happens now will affect trust between investors and an uncollateralised dollar, because the asset and credit markets are premised on the maintenance of ultralow interest rates to infinity.

American Exceptionalism

And, of course COVID and its variants linger. Because of COVID, the US has lost more Americans during this pandemic than those killed in World War II, its civil war or even the Spanish flu. Ominously, despite purchasing enough vaccines for 100 percent of their population, only 55 percent of the population is fully vaccinated compared to 80 percent in Canada. Although the US is among the world’s largest vaccine producers, they have the lowest vaccination rate of any G7 country with 70 million American remaining unvaccinated. And still, months after the vaccine approvals, more than half of the world remains unvaccinated. Yet American politicians are still denying there is a problem or even inequities. American exceptionalism has again been exposed by the pandemic, made worse by the unprecedented peacetime borrowings. We believe elements of American exceptionalism have eroded trust in government, undermined America’s international reputation and, ominously damaged America’s credit worthiness.

The greenback is America’s highest margin export. It is cheap to produce and is used by most of the world. This dependence on a fiat currency relies on the credit worthiness of that respective sovereign country. However, we believe its vulnerability is exposed by the unsound practices of the Federal Reserve or the European Central Bank or the Bank of England as they sink into the debt trap. The US has lost its reputation of financial integrity because the economy is so dependent on asset inflation. However, we think this financially engineered growth is vulnerable, particularly if the central bankers were to “normalise” rates to say 5 percent needed to stamp out 5 percent inflation, a level which would cause a house of cards collapse. Currently cryptocurrencies are touted as an alternative to money. It is not, crypto is an asset but it is not fungible in our day to day lives. Gold however is money. It is used by central banks as reserves and collateral and helped some people escape the Holocaust and recently, Afghanistan.

Dethroning the Greenback

From the stock market to property to credit, the string of bubbles has expanded in scope and risk. History shows that the bubble-prone US economy is a breeding ground for risk, aided by Wall Street’s financial engineering prowess. In 1987, the bubble was portfolio insurance strategy which did not protect investors from losses. In 1994, Wall Street designed interest rate swaps, which imploded. In 2000 the dot-com bubble burst cutting stock prices in half. And in 2007, derivatives of mass destruction caused havoc and a near depression. The bad news is that we haven’t learned from the past and bubbles are everywhere. New realities heighten the risk of unintended consequences. If the US Congress fails to raise the debt ceiling, sparking a “technical” default, the unintended chain reaction in the bond and derivative portfolios of investors will leave devaluation of the dollar as the one remaining option. Inflation is our next big problem. Monetary and fiscal policies to date have underweighted inflation but policies to “green” our economies and achieve net zero will in our view unleash and exacerbate the inflation forces. For now, American privilege remains exorbitant, but a substantially lower dollar is in the offing.

Of significance, is that the Cold War with China could also have long reaching consequences, particularly since China not only has been a big buyer of American government debt but also one of the largest holders of a treasury debt. However, recent figures show that China has been absent as a buyer over the last five months. Instead, China has been buying gold as an alternative to the dollar. China is the world’s gold producer and largest consumer. China’s gold reserves at 1,948 tonnes makes it the sixth largest holder after the US, Germany, Italy, France and Russia. China is also the largest importer of gold and its steady accumulation is believed to have topped the 8,143 tonnes of reserves held by the US government. Gold, in our opinion will a good thing to have.

What ballasts the US monetary system is debt and its weight is growing. The question is who will finance America’s debt if the Chinese decide to invest in gold or Japanese yen or sterling? Who will finance Mr. Biden’s spending spree? If the Chinese won’t step up to the plate, maybe the Fed could create another trillion or two with another “click” or mint a trillion dollar coin? While a rising tide lifts all boat and amid a market that records daily highs, everyone seems to be enjoying the liquidity but there are numerous signs than the liquid market is becoming illiquid. History shows that the consequences of higher inflation is higher interest rates, an outcome even more likely due to the deterioration of US government finances. Persistent growth in money and credit in the 1970s saw the price of goods and services go up to double digit levels – so did rates to stop inflation. Today, such growth has seen the prices of financial assets go up, and up. Today it is called a bull market. Another outcome of higher inflation though is much higher gold prices. While gold has lost seven percent this year and the broad markets post daily highs, inflation is rising. Gold is set to rise, it is a classic hedge against inflation. As such we continue to believe that gold will hit $2,200 as an interim target.

Recommendations

Noteworthy is that supplies of gold have been declining due to lower grades, with grades half of what they were a decade ago. Fewer discoveries have been made as the industry failed to replace declining reserves. Meantime, demand has picked up as central banks continue to add to their gold reserves. The industry is generating near record free cash flow and balance sheets are strong. The industry also boosted dividends and share buy-backs, sharing the wealth. While the industry is always on the prowl, most acquisitions are of the “fill-in” type. The industry also boosted exploration with hopes of organic growth via the drill bit. But other than discoveries in Newfoundland or northern British Columbia, there have been few plays.

We believe that the industry is in need of more consolidation. M&A activity in the past decade has been transformative with Endeavour consolidating West Africa, Northern Star in Australia and Newmont’s acquisition of Goldcorp and, Barrick’s bid for Randgold. Geographic risk is still evident as the nationalisation of Centerra’s major asset Kumtor in Kyrgyzstan resulted in the loss of billions. Barrick had problems in the Papua New Guinea and Eldorado has yet to find a partner for Skouries in Greece where permitting has been a problem.

11 The senior producers are in need of reserve replacement continuing a trend when the world’s largest gold miners, Barrick and Newmont bulked up through acquisitions a few years ago. Agnico Eagle is poised to snap up Kirkland Lake Gold for its reserves in the ground and double its production. This takeover continues the wave of consolidation in the mining sector because the larger senior companies are more popular with the passively-managed exchange-traded funds (ETFs). Also, the lack of gold funds and gold-type hedge funds has resulted in a dearth of check writers who in the eighties, financed the juniors on the premise that acorns grow into trees.

As such the developers with feasibility studies and delineated resources are favoured. We like McEwen Gold or a package of juniors with feasibility studies like Ascot, Bluestone, Orla, or Sabina. Exploration successes, Skeena and K-92 are strong development situations but are in need of feasibility studies. Among the seniors we like Barrick and Agnico on this weakness. We also like B2Gold and believe that Eldorado, Centamin and Lundin Gold will be future participants in the M&A game.

B2Gold Corp.

Low-cost producer B2Gold will meet guidance of 970,000 ounces this year with main flagship Fekola producing 550,000 ounces at AISC of $870/oz. B2Gold is expanding the Otjikoto Mine in Namibia, which will produce 200,000 ounces at AISC of $870/oz and Masbate in Philippines will produce 200,000 ounces at an AISC of $975/oz. Cash flow from operations will total $630 million with a stronger second half expected due to higher grades from Fekola and Otjikoto. B2Gold’s balance sheet is strong with cash of $382 million and an undrawn revolver of $600 million. B2Gold is reworking JV Gramalote and the project will be delayed a year. At Fekola, plans for nearby Cardinal is close to fruition. Kiaka in Burkina Faso is being updated. We like B2Gold here.

Barrick Gold Corp.

Barrick was rumoured to be a suitor for Kirkland Lake but balked at the offering price. That discipline also applied to its spending on capital expenditures on the largest array of Tier I mines. With 96 million ounces of reserves in the ground, the second largest gold producer in the world will spend $1.3 billion to extend the mine life of joint venture Pueblo Viejo in the Dominican Republic, which will unlock some 11 million ounces of gold reserves. Porgera will be brought on next year. Barrick’s Kibali mine in the DRC and Loulo-Gounkoto, the new underground mine in Mali will ramp up, benefitting from spending as Barrick seeks to grow organically. Barrick has more than $5 billion on its balance sheet. We like the growth prospects and shares here.

Centamin plc

Egypt’s largest gold producer Centamin’s main asset is the Sukari Gold Mine. Centamin has $312 million of cash, no debt and 3,100 km2 of exploration ground in Egypt. Barrick recently acquired four exploration licenses for 19 blocks in the Eastern Desert where Centamin’s mine is located Centamin produced 204,000 ounces in the first half and will produce 420,000 ounces or so this year. Centamin recently completed 79,000 m of drilling of which 49,000 m was underground as a prelude to a Phase 2 underground expansion. With reserves of 9.3 million ounces, Centamin has a 12 year mine life before going underground. Centamin has a two-year budget of $10 million and is ahead of Barrick as to knowledge of the area. Centamin earlier rebuffed a takeover proposal because the bid was too low. We believe that Barrick’s entry has vindicated the pioneering ways of Centamin and believe it will likely get another takeover proposal. Buy.

Centerra Gold Inc.

Centerra is locked in a battle after the seizure and nationalisation of Kumtor in Kyrgyzstan by the government. Centerra took a $926 million writedown of its largest asset and Kumtor filed for bankruptcy. Centerra had invested more than $3 billion in Kumtor. Mt. Milligan in British Columbia, Centerra’s other asset had a good quarter benefiting from better copper prices. At the Oksut mine in Turkey, production will be flat 100,000 ounces. Centerra has $800 million of cash, providing downside support but the lengthy negotiations make the shares dead. Sell.

IAMGOLD Corp.

IAMGold will produce less gold this year at AISC of $1,300/oz. IAMGold lost money, difficult for a gold producer. Rosebel production was lowered. IAMGold’s reserves are at 13.9 million ounces with a major part from Côté Gold, which is only 27 percent complete but requires almost a billion dollars to be spent after an update boosted costs for everything from processing, earthworks, concrete, labour, facilities and so on – completion is slated for 2024. While IAMGold’s balance sheet has $2.3 billion of liquidity, the company is betting the farm on a project that we remain skeptical. Despite a healthy cash position, the Company did a risky forward sell of 150,000 ounces with physical delivery for 2025. Sell

Eldorado Gold Corp.

Eldorado has almost 18 million ounces of P&P gold reserves showing the importance of its Greek assets. Eldorado will produce fewer ounces this year due to lower output from Olympias and Kisladag in Turkey. Over the near term, the completion of the high-pressure grinding roll circuit (HPGR) at Kisladag extends that mine’s life as well as the bringing on of the Triangle decline at Lamaque which will boost output. Eldorado has cash of $400 million and equivalents plus $150 million revolver, but needs to exploit Skouries which requires permits and some big dollars. An updated feasibility study is expected shortly with a 2-year production target as well as plans for the other Kassandra Greek assets. We like Eldorado shares down here.

Kinross Gold Corp.

Kinross will boost production in 2022 after a decline this year with future contributions from the Tasiast expansion, La Coipa restart and mine optimization from Round Mountain. Kinross is working on a prefeasibility on Chulbatkan (Udinsk) and a feasibility study at Lobo-Marte by yearend. Kinross has liquidity of $2.2 billion including $676 million of cash. Kinross has successfully operated in Russia for almost a quarter of a century, operating four mines with the latest Chulbatkan. Paracatu in Brazil is Kinross’ main flagship asset with annual throughput of 60 million tonnes and production of 540,000 ounces (GEO). The Northwest exploration might extend life of its pits. Projects like La Coipa and a La Coipa restart will take advantage of existing infrastructure are slated to be contributors. Lobo-Marte in Chile, on the other hand requires a big capex and is further down the road. In a day of M&A, Kinross might be an attractive tidbit for one of the majors. Hold.

Kirkland Lake Gold

Canadian miner, Kirkland Lake Gold was always thought to be an acquisitor given its premium priced paper. Kirkland owns three gold producers, the rich Fosterville mine in Australia which is among the highest-grade mines in the world, Detour which has long-life reserves but low grade and Macassa, a high grade but high cost underground mine. Kirkland is a cash machine, with no debt, and strong cash flow contributing to a strong balance sheet. It is that balance sheet and long-life reserves that attracted Agnico-Eagle to merge with Kirkland in an all stock US$10 billion deal that will result in a 3.4-million-ounce producer with 48 million ounces of gold reserves and a combined market cap of $24 billion. We like the combination and the megadeal puts two richly valued priced paper entities together with excellent management, solid balance sheet, which will provide a platform that will produce another Canadian global giant. Buy.

Lundin Gold Inc.

Lundin Gold will meet upper guidance at Fruta Del Norte in Ecuador this year due to a tonnage increase from 3,500 to 4,500 tpd at a capital cost of $18.6 million (throughput currently at 4,200 tpd). Fruta del Norte’s 10,000 m underground drill programme costs $11 million is looking for extensions. Lundin has key exploration lands of 38 km2 with priority targets at Barbasco and Puente-Princesa. Fruta del Norte is the richest deposit at 11 g/t, generating free cash flow of almost $80 million at all-in-cost of under $800 an ounce. We like the shares here.

New Gold Inc.

New Gold’s problems continue with a lowering of production guidance. New Gold does not have any debt due until 2025 which is fortunate since New Afton Mine and Rainy River mines are experiencing production problems. Lower grades from Rainy River’s “East Lobe” which was to be the bulk of Rainy River’s output this year resulted in a lowering of guidance and a downgrade. Similarly, New Afton’s gold production was lower increasing New Gold’s all-in-costs. New Gold’s performance has been disappointing with grades, execution and high costs a problem. Sell.

Newmont Corp.

Newmont’s near-term production increase is expected to come from the Yanachocha Sulfides and the Barrick joint venture Pueblo Viejo Expansion. Ahafo North won’t ramp up until 2024, but in the interim, Newmont’s production will be flat. Yanachocha Sulfides will require $500 million through 2022. However, Newmont’s cash flow is huge with $400 million of free cash for every $100 per ounce increase in the gold price. As such Newmont has liquidity of $7.6 billion, and possesses one of the strongest balance sheets in the industry. Still the Company is digesting Goldcorp with Coffee, Porcupine, Bordon and Eleonore remaining in the development state. And operational problems and weather caused a reduction in Boddington in Australia by 140,000 ounces. Nonetheless, the world’s largest gold producer has 94 million ounces of reserves in the ground with a robust 10-year plus gold reserve life. Newmont shares are a hold here but we prefer Barrick for its growth prospects.

Yamana Gold Inc.

Yamana has a flat production profile of 900,000 ounces with an all-in-cost of $1,000 an ounce due to by-product credits for the next few years. Jacobina, Yamana’s flagship production will increase from 230,000 ounces to 270,000 ounces with the Phase 3 expansion expected to offset declines. However, it won’t add production until 2027 and newly acquired Wasamac is too far off in the future with production not expected until 2026, at the earliest. With a stretched balance sheet of almost a billion in debt and flat output, we prefer B2Gold here. Sell.

John R Ing

[email protected]

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Gold is impervious to rust.

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