Gold: Inflation Is Enemy No. 1
Gold: Inflation Is Enemy No. 1
Source: West Central Tribune
Inflation is back. First Trump’s tariffs drove inflation and now his Iran adventure has created shortages and a global economic crisis, along with diminished missile supplies and a spike in oil prices. Whatever the strategic rationale, the president is eager for at least a settlement since our third Gulf war has unleashed a torrent of inflation, jeopardizing his party’s midterm chances, and the fate of his presidency. Moreover, his US allies, the rich Gulf states have borne the brunt of Iran’s retaliation and the blockade has resulted in a split in their ranks, along with supply chain bottlenecks, leading to massive shortages of everything from helium to fertilizers to jet fuel. The cost of a barrel of oil has increased by 50% since the start of the war. Mr. Trump’s decision to impose a counter blockade, so Iran can’t block it, which wasn’t blocked before Trump started the war, only escalates tensions and risk.
In 2024, China imported 20 percent of crude from Russia but almost 40 percent came from Saudi Arabia, Iraq, Oman and UAE. Only 13 percent comes from Iran today. The stalemate has led to an energy crunch rippling across electricity, gas and oil markets, with Asia among the first to come under economic attack, in the biggest energy crisis ever. The IMF reported that 12 or more countries have sought loans to cope with surging energy costs and the fallout also caused a shortage of fertilizer since the Strait is a key conduit, which raises the risk of millions going hungry, a problem that did not exist before. The world’s largest LNG plant, Qatar’s Ras Laffan Complex lost a good part of its capacity for years, not months. And, the UAE, a six-decade member of OPEC, abrupt exit cast doubts about the cartel’s future, opening deep faultlines in the Middle East and reshaping alliances such that OPEC might be the next casualty of this war.
Equally troubling, reopening the strategic lifeline doesn’t guarantee an end though. Rebuilding trust on all sides will take time, particularly when both sides consider each leader, a “madmen.” Is the president’s high-risk action that of a madman or as his supporters believe, a bold step to rid the US of a military and nuclear threat? Given that any agreement now sets up a no-winner contest, the likelihood of further escalation is unfortunately high. In a problem that the president helped create, Iran cannot be the tollkeeper, but sending warships into the twenty-one-mile-wide Strait, while discussing peace does not engender trust. If the US escalates further and bombs Iran’s power plants or desalination facilities, Iranians could asymmetrically target similar facilities in the Gulf in a tit-for-tat retaliation, or worse, block the Red Sea, the next fragile chokepoint.
Underlying the problem is inflation. As the Iran War fuels a cost-of-living crisis, inflation is running at 3.8 percent, double the Fed's goal. Prices are rising faster than wages, as today there are many more inflationary vectors than in the past. Tariffs were predicted to raise inflation to four percent or higher, and now supply disruptions and rising energy costs have created further pricing pressures. The fiscal gap is further widened by the $300 billion of tariffs that need to be refunded. Trump’s ill-fated decision to blockade Iran is also a sign of the risks and limitations, since the supply shock has already boosted commodity prices, especially at the pump. Farmers across the US are grappling with energy markets in turmoil and an unprecedented double whammy for diesel, fertilizer (made with natural gas) and feed, cripples their businesses. Detroit carmakers too warned of a $5 billion hit as the Middle East war strains supply chains for materials, aluminum, plastics and paint.
The Fallout
There are no winners in this war. Truce or not, utter chaos has engulfed the Middle East and unfortunately in opening “Pandora’s Box,” the president has not brought peace but a permanent state of instability which will have longstanding economic damage. Since it will take time and billions to replace damaged capacity, rebuilding will result in higher oil prices worldwide. Iran faces hyperinflation with the rial cut in half. Vitol the oil trader estimated that the world lost 2 billion barrels of crude and refined products, contributing to an economic cost in tens of billions, maybe trillions. Global reserves have fallen 380 million barrels according to the IEA. In a world that keeps springing geopolitical surprises, long after the fighting stops, famine and a systemic food crisis are the consequences of this war. Given that 75% of the world's population resides in nations that are net importers of fossil fuels, the lack of a worldwide reaction to this "made in America" problem is concerning.
The International Energy Agency called the war the “biggest energy supply disruption in history.” Early estimates put the direct price tag to US taxpayers at $29 billion and rising. To be sure, the prospect of oil remaining above $100 a barrel and the loss of 100 million barrels every week that Hormuz remains closed, will spark shortages as inventories shrink. If oil stays above $100 a barrel, the IMF has warned that the global economy risks its slowest growth since Covid, in the second inflationary shock in a decade.
As for the consuming countries, many including Canada are subsidizing users with tax breaks, subsidies and handouts. All are short-term palliatives since you can’t fix a supply problem by boosting demand. Also loosening the monetary reins and incurring more debt, only deepens the financial hole, as we learned in 2008. The United States is spending more money than it is receiving with more fiscal stimulus than during the Great Recession. As a result, we are unable to prevent inflation, which is a self-inflicted misery. While the US is least affected because of its energy self-sufficiency, politically Mr. Trump is most affected. Already the consequences are being felt at home with Spirit Airlines filing for bankruptcy due to rocketing fuel costs that will mean higher fares and, another boost to inflation.
With no end in sight, the war has given Iran a new weapon and they hold the Trump card in this game of chicken. The Strait was used by an average 150 ships daily and currently, Iran has set up the Gulf Strait Authority to administer permits and charge tolls. While the blockade is a violation of maritime law, noteworthy is that neither Iran nor US ratified the UN Convention Law of the Sea. Now Iran wants to maintain control of the Strait and the ability to charge tolls. Assuming the need to show co-operation with its neighbours, a charge of $1 million a ship would result in $3 billion revenue annually and those funds would be outside the Western-based SWIFT system. Blocking the Strait not only escalates tensions but risks pulling China into the war should the US seize a Chinese ship. As the Iran quagmire drags on, the spike in oil prices will be higher for longer, as we wait for an emboldened Iran to decide when to end the war.
To be sure America’s focus on military power has yielded dividends. Trump’s transactional approach utilizing American “might” has given him control of Venezuela’s oil reserves, the largest in the world. America’s growing energy dominance and a settlement of the Iran war would increase US influence over the Gulf. And, just as the Russian invasion of Ukraine benefited US shale oil producers, so does the Iran war benefit America’s LNG producers who have overtaken Australia and Qatar as the world’s largest exporter. America’s new energy dominance would give control of a critical part of the world’s energy, the Middle East, Venezuela and as the world’s largest shale producer, powerful enough to take on arch-rival China. That strength could be short-lived since this artificial shortage would eventually give way to global surpluses, flooding markets. History shows that it takes two to “taco.”
Domestically, the president has not been as radical. True, immigration was halted but it took two deaths and billions to stop the flow. True, he has been successful at deregulation but his support of cryptocurrency also made him and his cohorts richer. True, the president has expanded domestic energy production, but gas prices average $4.50 a gallon. True, that most Americans disprove of his job performance, particularly on inflation and immigration, but still there are no guardrails. True, this transactional president has advanced his “America First” agenda and despite his country’s dire finances, it appears its Trump First, as he reaps personal benefits as part of his deal machine.
And, despite the president’s violations of laws there have been few repercussions. Moreover, Mr. Trump views the stock market’s record highs as a barometer of his success. The president also views his tax cuts as the antidote to what ails the economy and consequently his quest to control the Fed is more important than control of Greenland or Canada. Wall Street too has feasted on Trump’s spending and tax cuts generating some $50 billion in revenues with its biggest banks posting record first quarter profits on the market’s volatility. It seems that war is good for the economy, at least for a while, until the hangover from spending follows.
The Coming Consequences
While Trumpism dominates our lives, the repercussions keep growing. Independent monitoring body, Global Trade Alert’s models found that if the war continues, global trade will collapse by the end of the year, with the biggest hit in the Middle East and Africa. The dangers of war is obvious. Oil reserves have collapsed as 2 billion barrels are lost with buffers and inventories almost depleted. A protracted war would lay bare a financial disaster from spiraling energy costs, gas lines, rationing, forced closures and famine. Today no one sees the chances of recession or even double-digit inflation. After all, things are different, aren’t they?
We believe that this Great Stimulus is simply an old-style monetary debasement which is inflationary, in the fourth supply shock in five years. To resurrect the economy after Covid or the financial crash of 2008, the government’s default policy was to use monetary policy. The AI spending boom and Mr. Trump’s One Big Beautiful Bill Act that cut taxes, injected trillions of dollars of stimulus into the economy. Already the sheer scale has driven bubbles in oil, Treasuries, asset prices and the stock market, as too much money chases too few goods. While a Volcker-style intervention of raising rates would burst the financial bubble, it would be political suicide, particularly when the Fed is divided like no other in its 112-year history.
Not surprisingly then we expect a huge inflation fiasco. Inflation this time will not be transitory. The price of oil itself has fed inflationary pressures but the fallout is only just beginning. The risk is great, even after the stalemate, that in a few weeks jet fuel shortages will follow oil shortages, let alone the prospect of food supply shortages. Fast growing Asia is particularly hard hit as supplies of energy and fertilizer are stuck in the Strait, raising prospects of shortages and famine. In response to the crisis, countries are exploring stockpiling and resource pooling as part of their national security issues, underpinning higher inflation in the future.
Today, the surge in velocity and inflation is part of a war psychology with trillions of anticipatory stimuli coming. Prior to the Weimar hyperinflation, there was a comparable golden age when overheated markets gave rise to blind pools, speculation, and gambling that permeated everyday life (hello Polymarket). Back then the German government’s printing press ran for nine years eventually causing the dreaded hyperinflation. With government debt above 100% of GDP and an abused monetary policy today, it is disconcerting that the US has started down a similar path today, where spending has become more addictive. At the same time government has run huge deficits not for years but decades and the war has crystallized risks. It is inflation that we should worry about since it happens to any nation that decides that inflation is an acceptable price to pay to achieve their economic goals.
High Inflation, High Interest Rates
Inflation nowadays is everywhere as companies, labour and governments lifted prices up, up, up to offset the cost of tariffs. Many risks forgetting the lessons of the past. Politicians now are obsessed with spending, but this time Mr. Trump’s guns and butter choice forces him to take control of the Fed and its printing press, bringing comparisons to the Great Inflation of the 1970s which almost bankrupted the nation a half century ago.
President Johnson made a guns and butter decision in the 1960s and used deficit funding to cover the costs of both the Vietnam War and his Great Society social initiatives, which sparked inflation. President Nixon then devalued the dollar after it lost its gold backing in 1971 due to the ensuing inflation, making it a fiat currency with no restrictions on government spending, further fueling inflation. That allowed legislators to create a bigger pie making all things possible, wars, pork barrel politics, handouts etc. Deficits and inflation exploded as the prices of food and oil spiked when oil soared over $135 a barrel. Central banks held monetary policy too loose. Then when Middle East producers imposed an oil embargo in 1973, the oil price quadrupled contributing to the Great Inflation earthquake ended when Paul Volcker, the Fed Chair, tightened money supply and pushed interest rates to double-digit levels, saving us from hyperinflation or morphing into a Great Depression.
And now inflation is back. Déjà vu, all over again.
This time, amid the fog of war, the United States has little cushion left to absorb another fiscal shock with consumer price inflation rising on a global basis. And today, the Fed’s $6.7 trillion balance sheet remains sky-high after huge bond buying sprees to resurrect the economy following the 2008 financial collapse and Covid pandemic. Shocking because in 2008, before the housing crisis, the Fed’s balance sheet was only $900 billion. Worrisome is that the Fed earlier bought trillions of dollars of government debt and now one third of those Treasuries and mortgage back securities must be rolled over this year and, at higher borrowing rates. US Treasuries are the archstone of the American financial system and considered “risk free” making up a good part of the Fed’s balance sheet. Then there is the cost of war in Iran as the US pursues Trump’s guns and butter choice. The projected fiscal and trade deficits call for the Fed to borrow the difference by selling Treasuries and monetize the deficits. However, given the size of the stimulus they are also sort of a financial Jenga as each spending block at the top destabilizes the edifice below. Much of those Treasuries were bought earlier as part of quantitative easing but Mr. Trump’s lack of spending discipline has created a flood of government debt that will collapse America’s debt Jenga.
Lessons From the Past
Compounding the problem is that today’s money market funds are forced into riskier short-term instruments because of the earlier removal of the overnight reverse repo facility, one of the potential safety nets that existed before 2008. The difficulty is that these security IOUs are today leveraged securities and must be paid back. With foreigners previously helping to fill the financing gap, liquidity has become a two-way street. Such is the state of the world that the richest states in the world, the Gulf states, normally big holders of US securities have dumped dollars because the Iran war has hit their finances. Simply the US is caught in a debt trap where inflation will push up borrowing costs, which in turn slows growth and increases the need for more debt.
Another factor is the private credit mess that raises fears of a repeat of the 2008 global financial style crisis that saw Lehman Brothers and Bear Stearns go bust, in the biggest collapse since the Great Depression. Culprits then were loose regulations, leverage and the implosion of derivatives created by Wall Street. Today, similar risks have moved public markets into the opaque private markets and the lack of oversight helped grow the $3.7 trillion private credit market, now larger than the balance sheets of all but four US banks. However unlike 2008, private credit doesn’t have depositors, instead non-bank financial institutions who borrowed from the big banks, problematic because they want their money back. Those illiquid holdings threaten again to sink Wall Street’s biggest firms with estimated lending exposures between $410 billion to $540 billion.
We believe that the Roaring Twenties, a golden age of social decadence and rapidly advancing economic and technical development, should be our concern rather than the Great Depression. In those days, the Dow Jones increased by 440 percent, from 70 in 1920 to 381 by September 1929. The US was a major economic force in 1920 thanks to developments in radio, telephones, and the Model T, which contributed to prosperity, change, and the "flapper" good times. In bubble-like conditions, financial assets quickly became overpriced. Early on, there was even a pandemic, the Spanish Flu, which caused public meetings and schools to close as the number of fatalities increased.
But there’s more. There was also a push for economic growth by building airports and highways as the population shifted from the farms to the cities. After spending almost half of US GDP on World War I, growing populism and a trade war led to the Smoot-Hawley Tariff Act to boost a weak economy and help farmers and domestic companies. Both Republican presidents Harding and Coolidge lowered taxes to 24 percent, and the combination of these expenditures, the Fed's lax monetary policies, and a protracted inverted yield curve supported the stock market boom of 1927–1929.
While the structure of the US economy has clearly changed since the early 20th century, there are some commonalities. The Roaring Twenties was exacerbated by a trade war that followed the Smoot-Hawley tariffs since countries retaliated in a “beggar-thy-neighbour” reaction. Global trade fell by 50 percent. We believe there are similarities as Liberation Day and American businesses and consumers bear the brunt of Trump’s tariffs that has fueled an inflation already twice the Fed’s target. In similarities between the current “irrational exuberance” tech boom and the Roaring Twenties, risk is real as the big tech giants Amazon, Alphabet, Microsoft and Meta spend more cash than they generate on trillion-dollar capital expenditures, inflating the AI bubble with Musk’s Space X IPO, the largest in history. Moreover with the Iran war creating one of the largest energy shocks in history, the coming tsunami of government spending will exacerbate inflation and the interest rate outlook. Then there is that North American Trade Treaty (USMCA), with America’s largest traders Canada and Mexico, where already a war of words threatens negotiations. Protracted negotiations would only cause more uncertainty and ensure higher inflation, leaving the United States less prosperous and less secure.
China Provides Mr. Trump An Offramp
Mr. Trump’s meeting with China was consequently important to both superpowers. Already on trade, Chinese exports to US has fallen 26 percent as companies shipped goods to Southeast Asia and India, removing one of Trump’s weapons and leverage. On the US side, everything from soybeans, to Boeings, to fertilizers, to currency were up for negotiations. At the summit between the two leaders, tensions were lowered but no breakthroughs were announced. The rules of the game have changed and it hasn’t been easy for the US to uncouple, instead in a recoupling move, both agreed to establish bilateral boards of trade and investment.
Seeing the limits of American power exposed by Trump’s war, China has patiently sat on the sidelines, letting America make its own mistakes and dig a deeper hole. China earlier recognized the importance of energy security, renewables and control of supply chains and has built or is building dominant positions in many of the areas that underpin a modern economy. The conflict allows China to leverage its clean energy advantage as a leader in global technology. China has other tools at its disposal. For instance, China lessened the energy damage because of its massive strategic crude oil reserves of 1.4 billion barrels, compared to the United States' 413 million barrels, giving it crude leverage. While exports tripled in the past few years, China used its supply-chain dominance to counter Mr. Trump’s byzantine tariffs and did not need to retaliate with quid-pro-quo tariffs but instead imposed an embargo on rare earths and critical minerals, crucial to the functioning of the American economy.
The Hormuz blockade has sharpened focus on other strategic chokeholds. For example, China’s near monopoly of 90 percent of processing of rare metals needed for almost everything from smartphones, to AI, to F-15 fighter jets has seen a scramble with the US funneling billions into dubious rare metal plays which carry either sub-par grades or lack sufficient reserves or crucially, the metallurgical processing facilities which currently reside in China. Those Tomahawks and Predators require rare earths for their guidance systems whose resupplies now and in the near future remain dependent on China. China produces 94 percent of rare-earth magnets, a key component of engines. Today investors must cope with war in the air, the seas, and specifically critical materials.
In addition to producing more ships, trains, electric vehicles, and pharmaceutical ingredients than the rest of the world put together, China produces one-third of the world's commodities. China benefits from scale, particularly in the areas of AI and, crucially, renewable energy. China’s exports of solar panels, batteries and electric cars reached almost $22 billion in March, 70 percent higher than a year ago, underpinning its low-cost manufacturing sector. With a trade surplus of $1.2 billion which is also a net export of savings, China’s leverage in commerce and now renewables gives it an opportunity to penalize or retaliate in a subtle use of soft power, compared to US “hard power” which bludgeoned enemies and allies alike with the president’s aggressive trade practices. Yet China too has flexed its muscles, warning EU that its “made in Europe” bill would attract retaliation and countermeasures.
America’s Achilles Heel
The economic emergence of China prompted President Xi Jinping to ask Donald Trump whether they could avoid the Thucydides Trap, described in ancient Greek history, in which incumbent hegemon Sparta’s fear of a growing Athenian power, led to a battle for dominance that ultimately led to the Peloponnesian War. Harvard historian Graham Allison noted that in a dozen times in history, when a rising power threatened to overtake the established power, the result ended in bloodshed, in ten of twelve times. Mr. Xi’s warning went unheeded.
Once before another global hegemon, the British Empire ruled the world. But shortly after financing two world wars, Great Britain inflated its money supply to cover the war costs. Then in 1956, both the British and French empires supported Israel’s seizure of the Egyptian controlled Suez Canal, intent on overthrowing the government, but the attendant costs hurt British debt triggering a weaker sterling. The Egyptians defended and sensing weakness seized and nationalized the Suez Canal, cutting off the oil supply once controlled by Britain. Sterling collapsed further. Ironically the US worried that the war would help the Soviets, forced London to withdraw and their reluctance to use its military might, weaponized their financial power, forcing Britain to sacrifice the Suez. That ended its hegemon status as a superpower to be replaced by that rising power, the United States. Ironically, back then it was the Suez Canal, today it is the Strait of Hormuz and, Donald Trump’s self-created Suez trap has China as a patient bystander.
Today deeply in debt, the US has become a rogue superpower. The US has threatened both allies and enemies alike focusing instead on America First undermining the very institutions that underpinned global stability for over half a century. Trade is coerced, economic blockades and sanctions are weaponized suitable of a protection racket. Everything has a price, which is the same logic that contributed to two World Wars. While the first six days cost $11.3 billion, the cost for replacing US weaponry and infrastructure is estimated at $2 billion per day, including munitions, soldiers and damage to military assets. The Pentagon has estimated the cost to date at $29 billion and with the price tag rising, the White House is seeking to boost its defense budget to $1.5 trillion, up from $1 trillion while the cost of the Iraq war is estimated at $2 trillion, the nation’s debt however was only $4 trillion. Today, the national debt stands at $39 trillion and climbing, leading to a persistence inflation. Wars cost money and can bankrupt nations. Debt on debt is not good.
The Unsustainable Will Not Be Sustained
Yet the US continues to spend for everything from new submarines to unfunded tax cuts to a new White House ballroom and for much of the past decade the US has been borrowing more and growing too little. America has a spending problem, ignored for years. Since 2000 after the global financial crisis, money supply measured by M2 has grown by nearly 160 percent, as the Fed’s easy money policy provides cheap credit through abnormally low interest rates that encouraged more risk-taking and record stock markets. The Fed controls the monetary supply, the feedstock of inflation by purchasing and selling assets (Treasuries) in the open market. Today America’s debt topped $39 trillion with interest payments exceeding $1 trillion, more than they spend on defense, compounding the strain. The total federal spending blowout increased 4 percent in March in spite of DOGE’s promise to cut $2 trillion from the government’s budget and instead increased causing concern over the trajectory of the deficits.
With $39 trillion in debt, the US is now the world's biggest debtor, with foreigners owning $9.3 trillion, or 24% of that total. The United States’ balance sheet peaked at nearly $9 trillion, leveraged from the 2008 financial crisis and Covid bailouts, and that liquidity fueled the record-breaking markets, financed in large part by margin debt. In echoes of the Twenties, borrowed money, the deregulation of the finance industry, and the big banks’ day-to-day role as asset creators and gatherers, played a key role from the crashes of 1929 to the 2008 crash. We believe America’s huge debt burden and rapidly inflated supply of dollars has made the US vulnerable to financial warfare, as wars and the scaling back of US assets exposes their vulnerability. Everyone is hoping that the unsustainable will go on a little longer. It won’t.
America’s Achille’s heel is its debt. We believe that the US dollar must fall as it becomes a casualty of America’s isolation. Americans have virtually no savings and only half of all Americans earn less than $45,000 per year, not enough to finance those deficits. Finance is another area where trust is being undermined. The dollar was once a source of stability, but nations looked for alternatives when it was weaponized as part of Trump's tariffs and used to increase pressure or force other countries.
A large part of US debt is held by China and the Middle East countries who no longer wish to hold dollars, as the war lays bare the geopolitical faultlines in the Middle East. Trump’s bullying behaviour and military adventurism has eroded US soft power globally. It is concerning since the global financial system has been rewired in recent years, that the dollar's stranglehold on that plumbing has decreased over the last ten years, from 65 percent to less than 57 percent of reserves. The Iran war has recently caused an outflow of dollars and Iran and Middle East now accept yuan, euros and yen instead of petrodollars which was the cornerstone of its financial dominance since 1973. The significance of the Western-based payment SWIFT system was also diminished when China, one of the largest clients in the Middle East, established its own Cross-Border Interbank Payment System (CIP) long ago to reduce exposure to US financial sanctions.
It Is Hard to Drown in A Sea of Liquidity
Despite the Middle East and Ukraine wars boosting inflation, stock markets have surprisingly recorded fresh all-time highs, as easy money and a flood of liquidity sends markets into an exuberant state, reminiscent of the Gilded Age. It is hard to drown in a sea of liquidity. That is the logic behind the bull market today. A technology tailwind was created by the development of artificial intelligence (AI) and its revolutionary features, and the AI euphoric over a small number of mega-techs have driven stock prices to all-time highs resembling the dotcom boom and bust. With 60% of Americans owning stocks, holding stocks has become a popular hobby. Fears of a bear market are nowhere as complacency is everywhere on a tide of optimism with trillion-dollar Space X, OpenAI and Anthropic IPOs. Yet while the parabolic performance of stock markets hit successive record highs, consumer sentiment has sunk to lowest in 74-year history. Why the disconnect?
Are markets discounting ahead and looking across the valley for a V-shaped recovery of better times? Instead of a much-feared crash, will "buy the dip" strategy prove successful once more as stock prices recovered after Covid, Russia's invasion of Ukraine, or Liberation Day, that erased earlier losses? Those who “bought the dip” benefited from a recovering economy. Could the market’s resilience be assuming a better economy, after the Iran war? Or, are investors ruling out the worst case because of the widespread belief that Donald Trump will always back off, particularly when the market dips, popularly known as the TACO trade, “Trump Always Chickens Out.” It is a risky game. All of which suggests that the old trader’s adage that “rising tides lifts all boats” is a truism, but be careful when the tide goes out.
Fundamentals, in our opinion, are more important than buying the dips or attempting to respond to every post by Donald Trump on Truth Social. And despite going through a once-in-a-century change in technology, media and politics, the old school law of supply/demand remains all important, as economic warfare creates winners and losers with Wall Street, one of the big winners, feasting on volatility that generated some $50 billion in revenues, while losers are Iran’s rich neighbours caught between missiles, US bases and lost oil and gas reserves. However the biggest loser, amid the geopolitical chaos, is America with its stretched finances. The great power conflict between the US and China risks a secular change, where a seemingly regional Middle East conflict can turn into a far-reaching global recession. At the very least, the clock is ticking on Operation Epic Fury as the Strait’s closure brings the United States closer to another financial rupture, as in 1970 or 2008, when the unsustainable won’t be sustained.
Markets Are Out of Sync with Reality
President Trump promised an economic golden era when he started his second term. Instead America’s finances are at risk of becoming unhinged after running chronic deficits, now exacerbated by the war. In the past five years, US consumer prices have risen 5.25 percent while wholesale prices a forerunner of consumer inflation, rose 6 percent in April. Higher inflation will not only hurt consumers but government finances are already stretched. The White House has slashed regulations to lift housing supply, bought bonds to push down mortgage rates (already at 6 percent) and now a debt tsunami is poised to hit. Tariffs have already raised everyday prices. The war will keep inflation higher for longer.
The paradox is seen between the divergence of stock prices and government bonds.
The bond market is the first to trigger economic trouble with yields near multi-decade highs. Higher inflation has pushed 10-year Treasury yields 100 points on inflation angst. The yield on a 30-year Treasury bond has reached historic heights, the highest since the financial crisis of 2008. Each auction brings fewer foreign buyers. Mortgage costs, corporate borrowing rates and the interest on the nation’s debt keep rising forcing the government to borrow even more to service the growing debt bill. Despite a roaring stock market, markets are fragile and the rallies have become increasingly narrow in breadth. Although there are appearances of a greater risk appetite, the inflation shock is only just beginning. Interest payments on US government debt today exceeds what they spend on national defense. Higher rates go hand in hand with higher inflation and that means the eventual need for the new Fed chair to rein in money supply which has been growing at double-digit levels.
It is this contradiction and contraction that central bankers fear most in shades of the Great Depression. However, it is not the Great Depression that should worry us, it is hyperinflation. Today the politics of debt reduction or spending cuts is nowhere to be seen, not with a president doing everything to lower rates and boost the economy. To finance wars, tax cuts, bailouts etc. and growth, the government has become increasingly debt dependent but higher inflation and higher rates remove the props to that growth. While there is ample evidence of the link between fiscal profligacy and subsequent inflation, inflation increases when demand exceeds supply, while deficits raise demand. If the fiscal deficits are not accommodated by money supply, the deficits push up rates. That is when the tide goes out. That is what happened in 1929.
The Golden Constant
The US has been living way beyond its means for some time and amid currency worries, gold reached new highs at $5,500/oz this year. What damages trust in the US damages the world. Today, the dollar currency system, the bedrock of the Western financial system is broken, after a series of stress from moving off the gold standard in 1971, to the US-Japan crisis in the 1980s that led to the Plaza Accord, to the 2008 financial crisis and the inflation crisis of today. All this suggests that the US is losing its unilateral status in a multi-polar world and they will soon face a financial crisis, without sufficient wealth or friends to purchase their enormous amounts of debt. The US has reached a tipping point when the dollar failed to act as the traditional safehaven, due to the scale of its US budget and expenditures.
Gold consequently has been a beneficiary of this dollar debasement as the proverbial canary in the coal mine. Gold is an alternative investment to the dollar for central banks. Except for last month, central banks have been major buyers of gold for the past three years, as an alternative to the dollar buying up to a quarter of supplies. Their purchases were part of an almost two centuries old tradition reflecting gold’s role as a safehaven or store of value. China bought 160,000 ounces in March for the eighteenth month in a row of continuous purchases. We believe gold will top $6,000/oz which is our interim target.
Gold’s main driver is US policy volatility which makes investors wary of holding dollar assets. Gold now exceeds Treasuries held at central banks’ foreign reserves. Ironically the world’s biggest holder of gold is the US with 8,134 tonnes, followed by Germany and IMF with 2,814 tonnes. China has joined the 2,000-tonne club of Italy and France. Gold is simply seen as a less risky alternative to the dollar, and a hedge against geopolitical uncertainty.
Despite the gold miners becoming huge cash flow machines with rock solid balance sheets, gold mining shares have corrected. First quarter results were better than expected with record margins. Costs were elevated, however. We believe this recent share weakness presents an attractive purchase opportunity. Although reserve growth has been flat due to the fact that over the decades, the low hanging fruit discoveries have been discovered and that it can take decades for projects to come on stream. There are no new supplies coming on stream, while demand keeps increasing. The lack of reserve is an industry problem. Consequently, organic growth is centered around existing deposits with Barrick’s Nevada Gold Mines or Agnico’s Finland gold district as solid examples. On the other hand, M&A activity remains robust with Ross Beaty’s Equinox acquiring Orla in an $18.5 billion deal to create a 1.1-million-ounce annual producer with growth plans to almost double to 2 million ounces. However the deal is long on potential with high hopes that Valentine and recently acquired Musselwhite will match optimistic expectations.
Consequently we continue to focus on the growth seniors and the developers who are most likely to bring on production in the current bull market cycle. We like Agnico Eagle and Barrick among the senior producers and prefer the developers. B2Gold, Endeavour Mining and Lundin Gold here.
Recommendations
Agnico Eagle Mines Ltd.
Canada’s largest gold miner Agnico Eagle had a strong quarter producing 825,000 ounces at AISC of $1,500/oz with record mill throughput at Macassa, and increased tonnage at Detour. The company expects that expansions at Upper Beaver, San Nicolás, flagship Malartic and Detour to contribute between 20 percent to 30 percent growth over the next decade. Agnico announced an agreement to buy junior Rupert Resources’ Ikkari project as well as B2Gold’s stake as part of the consolidation of the Finland Central Laplands centered on nearby producer Kittila. The move is comparable to Agnico's plans to bring on Hope Bay’s material to process at existing Nunavut facilities. Agnico’s positive PEA study calls for spending $2.4 billion on Hope Bay to produce 400,000 ounces per year at 19 percent IRR. We continue to like Agnico for its Canadian brownfield development projects.
Barrick Mining Corp.
Barrick had a strong quarter producing almost 720,000 ounces at an AISC of $1,700/oz. Barrick maintained guidance of 3 million ounces this year. Barrick also reported that they are on track to complete the IPO of a minority stake in Nevada Gold Mines (NGM) Joint Venture and Pueblo Viejo in the Dominican Republic later this year. Nevada Gold Mines is the world’s largest gold complex and will produce about 2 million ounces. Largely North American focused, NGM will provide investors exposure in the promising Tier 1 asset of Nevada Mines and potentially 100 percent owned Fourmile, a key asset. Reko Diq in Pakistan was put on hold pending security and financing. While investors will like the IPO, we prefer that Barrick keep the assets and focus on building out Fourmile. Barrick is a cash-flow machine and has the largest array of Tier 1 gold assets in the world. Barrick’s African/Asian copper assets provide important copper cash flow benefiting from global energy demand. Regaining Loulo-Gounkoto will help results. We continue to recommend undervalued Barrick here.
B2Gold Corp.
B2Gold posted a strong quarter producing 238,000 ounces at AISC of $2,000/oz of which newly commissioned Goose in Nunavut provided 43,000 ounces as Phase 1 crusher upgrades will allow processing at 3,200 tpd. Goose’s results were disappointing partly because of a fire in the crushing circuit which hurt output. Production however was better at Fekola in Mali, Masbate in the Philippines and Otjikoto in Namibia. B2Gold is still waiting for the Fekola regional exploitation permit which will allow expansion of its Mali facilities. B2Gold’s sale of Fingold for cash and formalized co-operation agreement with Agnico Eagle will help B2Gold develop Goose’s Phase 2 which is also in Canada's Nunavut. At Gramalote, B2Gold’s next mine, the EIS was tabled. B2Gold is in transition, yet the company has in place a solid cash flow machine. B2Gold ended the quarter at almost $480 million cash against total debt of $520 million. We like the shares here.
Centerra Gold Inc.
Centerra produced 68,000 ounces and 14.2 million pounds of copper from Mount Milligan. Centerra also announced the results of Kemess PEA which is a revised mine plan for a former producer. The early-stage PEA outlines a 15 year mine life and annual production of 171,000 ounces of gold plus 61 million pounds of copper at AISC under $1,000/oz. Leveraged to gold, the project’s IRR is 29 percent at $4,500 per ounce of gold. The project however requires almost $1 billion of capital which is manageable for Centerra because of its strong balance sheet. Nonetheless Centerra is in need of a flagship since Kemess is a fill-in candidate. Centerra continues to advance Goldfields in Nevada and this project too is still in the development stage but could be in production by 2029. Meantime the Molybdenum Business Unit is still a drag on results. We prefer B2Gold here.
Eldorado Gold Corp.
Mid-tier producer Eldorado Gold had a disappointing quarter producing 100,000 ounces of gold due to lower tonnage from mines Kışladağ and Efemçukuru in Turkey at AISC of $1,942/oz. At Lamaque, the Québec mine produced 42,000 ounces up 5 percent with contributions from Ormaque. Importantly the Skouries buildout is almost finished allowing the company to gamble on Foran Mining’s $3.8 billion MacBay. We did not like Eldorado's acquisition for MacBay in Saskatchewan which primarily increases Eldorado’s copper exposure and decreases its gold exposure which like Skouries, has yet to fulfill expectations. Consequently the company will be in a neverland until either buildout prospers or fails. Sell.
Endeavour Mining PLC
Endeavour had a strong quarter and maintained guidance of 1.2 million ounces at AISC between $1,600 - $1,800/oz. Tier 1 Sabodala-Massawa had a strong quarter. Endeavour is the largest gold producer in West Africa with mines in Senegal, Burkina Faso and Côte d’Ivoire. With Sabodala complete, the company is building its main growth asset, the Assafou-Dibibango project in Côte d’Ivoire, with a feasibility study expected this quarter and first production in second half of 2028. Assafou has strong economics. Endeavour plans to file the decision for the end of the year and at $4,000 gold, Assafou could have an after-tax value of over $5 billion, producing 320,000 ounces per year at all in cost under $1,000/oz. Of interest is that Endeavour has spent $20 million for a 9.9 percent interest in Fortuna which has a large ground position in Guyana. Guyana is developing into a promising gold district with a pro-mining environment and majors are looking around for exposure, to duplicate the success of Omai Gold Mines, which is a growing junior with a resource around 8 million ounces up from 1.5 million ounces, only a couple years ago. We like Endeavour here for its growth prospects.
IAMGOLD Corp.
The miner produced 184,000 ounces at AISC of $2,124/oz in the first quarter. IAMGOLD has cash and cash equivalents of $550 million which is a big turnaround from a year ago due in part to Côté Gold Mine finally coming on stream as the miner released a resource update to boost output. Côté produced 75,000 ounces in the quarter at all in cost of $2,100 an ounce. However IAMGOLD’s results were boosted by Essakane which produced 112,000 ounces allowing IAMGOLD to pay down debt. Westwood had a strong quarter on better grades. IAMGOLD’s guidance is 720,000 to 820,000 ounces this year and its balance sheet should improve. Nonetheless we prefer Endeavour here with a broader array of assets.
Kinross Gold Corp.
Kinross produced 493,000 ounces in the quarter in line with expectation. Both Tasiast and Paracatu had strong quarters due to improved mill recoveries and better grades. All in cost was $1,700 an ounce and free cash flow was a record $838 million which included payment of $450 million of taxes. Kinross has a strong balance sheet, ending the quarter with $2.2 billion of cash and $3.9 billion of liquidity. Tasiast will produce 500,000 ounces this year. Looking ahead, Kinross’ pipeline includes expanding existing operations at phase X at Round Mountain, Bald Mountain and Curlew in Washington. Great Bear remains too far off in the future to affect results. We prefer Endeavour here.
Lundin Gold Inc.
Lundin had a strong quarter producing 120,000 ounces from 100 percent owned Fruta del Norte (FDN) mine in Ecuador. Importantly tonnage hit a record 5,520 tons/day and Lundin expects to meet guidance this year. Importantly, one of the world’s highest-grade miners is a cash flow machine producing $349 million in free cash flow, adding to a balance sheet of over $700 million. The company plans to bump up its throughput beyond 5,500 per day and has aggressively explored extensions of FDN. Exploration has already outlined three porphyry systems. Lundin is well-placed with a large land position and nearby satellite discoveries can be processed at the main plant. We like Lundin here for its rich grade, long life and exploration potential.
McEwen Inc.
McEwen Mining had a strong quarter from its collection of mines that generated net income of $33 million. McEwen's multi-asset growth strategy includes the Fox complex in Timmins, developing Tartan mine in Manitoba, El Gallo in Mexico and Gold Bar in Nevada. San Juan in Argentina throws off dividends and most importantly McEwen Copper which is 46 percent owned by McEwen Mining is on track to become one of the top mines copper mines by 2030. McEwen's debt placement valued McEwen Copper at US$8.00 a share, so the parts are worth more than the whole at this time.
Newmont Corp.
Newmont had a strong quarter, generating $3.8 billion in cash flow in the first quarter. Newmont maintained its guidance producing 6 million ounces of gold at AISC cost on a byproduct basis of $1,000/oz. However, Cadia had a seismic event which resulted in a cessation of activity, interrupting production so second-quarter production will be affected. Moreover, nationalist politics raised its head with a new Ghana mining royalty that will increase costs as well as Ghana’s mining regulator’s insistence that the industry move to local contractors. Of concern Ghana’s nationalistic policies includes raising the output that miners must sell to the central bank to 30 percent from 20 percent and at a full percent discount to market price. Newmont has a large reserve position which is its strongest asset, however, given the combination of maturing mines and the need to prune its mixed global portfolio, growth will be a problem. We prefer Barrick here.
John R. Ing
Please refer to the Legal Section of our website (maisonplacements.com) for our Research Disclosures for an explanation of our rating structure at https://maisonplacements.com/research-reports/.
*******
