A Most Unusual and Interesting Gold Market

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Source: Ron Struthers for Streetwise Reports   09/19/2018

Ron Struthers of Struthers Resource Stock Report reviews the current status of the gold market and discusses four gold miners on his buy list.

This is one of the most unusual and interesting gold (GLD) markets that I can remember in well over a decade. There are several factors at play that include:

  • Trade war with China becoming a currency war.
  • India's tax situation.
  • Commercial traders are net long for the first time in 17 years.
  • Gold sentiment at extreme lows.
  • Kinesis, a new gold-backed cryptocurrency.
  • Year-end is approaching, which is often volatile for gold prices.
  • Gold stocks cheaper than 2015 bottom.

In January, the Trump administration began imposing tariffs on various products and countries that intensified a trade war. On July 6, when the U.S. imposed tariffs on China the trade war escalated further and started to become more of a currency war. The yuan to US$ exchange rate was already falling in 2018 and dropped further after the July 6 announcement (I have July 4 highlighted on the chart). In essence the devaluation offset the tariffs.

Simultaneously, China has been using its US$ reserves to buy cheaper US$ priced physical gold to maintain the CNY to Gold peg. This helps facilitate yuan-based oil purchases because oil producing states can immediately convert their yuan to gold through the Petro/Yuan futures contract. This is resulting in more physical demand for gold from China that will rival the 2013 highs. This graphic using World Gold Council data shows China on track to hit 1,000 tonnes this year and with demand picking up in the second half of 2018, it should come out above 1,000 tonnes.

While demand from India, the second largest consumer, looks soft, it does take into effect smuggling and a tax loophole. Gold is subject to a 10% import tax, but if doré bars (not pure or refined) are imported, the tax is avoided is how I understand it. The import of doré bars removes supply to refineries elsewhere. In 2016, the World Gold Council estimated smuggling into India amounted to 120 tonnes.

Many gold traders, including myself, watch the weekly COT Report. Typically the Commercial traders are short gold and Managed Money is long when gold has rallied. Commercials will typically trigger gold to fall through support levels and as Managed Money sells, the Commercials buy to cover their short position. Once the Commercial short position is very low, gold rallies and the process repeats. Some call it the rinse and wash cycle. It is very unusual to see Commercials with a net long position, but we have that now for the first time in 17 years. This is very bullish as the Commercials are considered the smart money.

On the gold chart, noted with the arrows, the COT is more bullish than the December 2017 low and even the bear bottom low of December 2015 (not shown here). I also note with the circle an almost perfect morning doji star reversal pattern. These are strong reversal signals and I would now like to see a break above $1225 as further confirmation of the August bottom.

There is also a new bullish factor in the market that might be as significant as when numerous gold ETFs arrived in 2004 to 2010 that helped propel gold to the 2011 highs. The latest scheme is a gold-backed monetary system cryptocurrency called Kinesis.

There have been some other gold-backed cryptos helping to draw mainstream attention to gold as a safe-haven asset, but it is important to differentiate what Kinesis is. Not only does the Kinesis currency provide a yield, but Kinesis defeats Gresham's Law, which no other gold-backed cryptocurrency does. In fact, Kinesis isn't just another a cryptocurrency, it is actually 100% physically backed digital gold trading via blockchain.

Kinesis was born from the team at Allocated Bullion Exchange (abx.com) who operate an institutional exchange in spot physical precious metals, with partnerships with Deutsche Borse, government postal systems and many others. The physical metal holdings will be inside the ABX secure quality assured environment. The ICO will be the largest in history and was launched September 10 ending November 11. So far there is over $57 million in sales in just the first few days from launch.

This next chart I start dragging out every year in the fourth quarter and we are close enough. Gold has seen weakness in December in every of the last 10 years. I did not update the chart as it just shows an estimate for the 2017 bottom. We know from the chart above that the December 2017 low was about $1260. It begs the question: Will gold drop to new lows in December 2018? I would be very surprised to see a lot more weakness with the current COT positions. I believe the most likely scenario is a rally to around $1280 to $1300, topping out in October or November sometime, and then a drop back down in December or this year is different.

There are a number of indicators I point out above that could tighten the physical market in gold. There are also a number of other positive fundamentals. A Fed rate hike is baked in for the September 25–26 meeting. Gold has most often been weak ahead of the rate hike and rallies after it is announced. There are still tensions in Iran and the ongoing trade disputes that could spur a flight to gold. Uncertainty leading up to November mid-term elections. September and October are historically the most volatile months for the stock market. September has been good so far, but maybe October will get ugly and gold will benefit as a safe haven. All said, what I see as the most bullish factor is how cheap and oversold gold stocks have become.

On this HUI (NYSE Arca Gold BUGS Index) chart, the stocks have come to a support level around 135, the resistance level back in 2015. Very seldom do you see a reading on the RSI indicator well below 20. In fact I don't remember seeing that in the past 10 years or more except the 2015 bottom and now the August 2018 low. What is most significant that gold stocks are only about 20% above the 2015 low when the gold price was about $150 lower and gold companies have since tightened up their cost structures. In short, this is the best opportunity I have seen to buy gold stocks since the 2002/03 and 2015 lows. It could even be a better opportunity today.

We have been stopped out of all of our gold stocks now except Semafo. I have four Gold stocks in mind to buy back and in part because their call options are also good buys.

Kinross Gold Corp. (K:TSX; KGC:NYSE), Recent Price $3.88
Opinion: Stopped out at $4.20, Buy back

I like Kinross for the cheap price on the chart, but also high leverage to the gold price. In its recent Q2 report, the company was barely profitable, earning US$2.1 million in the quarter. An increase in the gold price will have a substantial impact on the bottom line.

Kinross expects to produce 2.5 million Au eq ounces (plus or minus 5%) at a production cost of sales per Au eq oz of $730 (plus or minus 5%) and all-in sustaining cost of $975 (plus or minus 5%) per ounce sold on both a gold equivalent and byproduct basis for 2018. Total capital expenditures are forecast to be approximately $1,075 million (plus or minus 5%).

As of June 30, 2018, Kinross had cash and cash equivalents of $918.7 million and available credit of $1,566.4 million, for total liquidity of approximately $2.5 billion, and no debt maturities until 2021.

The enterprise value of Kinross is also attractive compared to many peers. On the chart we are at a mild support level from 2016 and more important is a morning doji star reversal pattern. Together, that is good odds of a bottom.

For call options, I like January 2019 US$3 Calls at $0.32 going out a year longer and the premiums are not very high. January 2020 US$3.50 Calls can be had for about US$0.35.

On the Canadian side, I would go with January C$4 Call for about C$0.35 and longer term the January 2020 C$5 Call for about $0.35.

Goldcorp Inc. (G:TSX; GG:NYSE), Recent Price $13.80
Opinion: Buy

Goldcorp has not been on my list for a couple of years, but I like Goldcorp now because of a substantial sell off in the stock, just ahead of a good growth phase for the company. The company has what it calls a 20/20/20 plan, which is 20% growth in production and reserves with a 20% reduction in costs. The growth chart is from its presentation.

Production in 2018 is expected to remain at 2.5 million ounces with good increases in 2019 and 2020.

In Goldcorp's Q2 report, gold production was 571,000 ounces at all-in sustaining costs (AISC) of $850 per ounce, compared with 635,000 ounces at AISC of $800 per ounce for the three months ended June 30, 2017. Ramp-up of sustainable capacity at Éléonore and Cerro Negro continued and is expected to be a key contributor to increasing production in the second half of the year. Full-year 2018 guidance reconfirmed for gold production of 2.5 million ounces (plus or minus 5%) at AISC of $800 per ounce (plus or minus 5%);

The project pipeline continues to advance in support of the company's 20/20/20 growth plan. The Peñasquito pyrite leach has completed construction with commissioning further accelerated to the third quarter of 2018, now two quarters ahead of schedule, while the Musselwhite materials handling project advanced to completion of 76%, on schedule and 10% below budget.

On the stock chart, it is quite amazing to see the stock all the way back to the 2015 bottom around $10. It does not show on this longer-term chart, but about the same time as Kinross, a morning doji star reversal pattern occurred.

For options, I like the January 2019 US$10 Calls at $1.16 Further out, I would go with January 2020 US$10 Call around $2.10.

On the Canadian side, the January 2019 $14 Call at $0.95 and longer term, the January 2020 $15 Call at $1.80

B2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX), Recent Price $2.87
Opinion: Stopped out at $3.00, Buy back at $2.80 or less

With B2Gold, the stock has better relative performance than most gold stocks because of strong growth in 2018. However, the stock was still punished and has come down to a strong support level, so the downside risk looks small.

The strong growth is evident in its second quarter 2018 highlights:

  • Record quarterly consolidated gold production of 240,093 ounces, a significant increase of 98% (118,645 ounces) over the same period last year and 7% (16,308 ounces) above budget, due to the continued strong performances of the Fekola mine in Mali, the Masbate mine in the Philippines and the Otjikoto mine in Namibia.
  • Consolidated gold revenue of $285 million, a significant increase of 73% ($121 million) over the same period last year.
  • Consolidated cash operating costs (a non-international financial reporting standard measure) of $474 per ounce, well below budget by $86 per ounce (15%) and $157 per ounce (25%) lower than the prior-year quarter. Consolidated all-in sustaining costs (AISC) (A non-IFRS measure) of $721 per ounce, significantly below budget by $146 per ounce (17%) and $253 per ounce (26%) lower than the prior-year quarter.
  • Consolidated cash flows from operating activities of $86 million (nine cents per share), significantly increasing by $38 million (79%) from $48 million (five cents per share) in the prior-year quarter.
  • Net income of $21 million (two cents per share) and adjusted net income (a non-IFRS measure) of $46 million (five cents per share)

The strong growth is mostly attributed to the new Fekola mine that started production in late 2017 and continues to operate above plan, producing 112,644 ounces of gold in the quarter, 11% (11,225 ounces) above budget, at cash operating costs of $318 per ounce and AISC of $445 per ounce. Based on Fekola's strong year-to-date performance, Fekola's annual production guidance was revised higher to be between 420,000 and 430,000 ounces of gold (original guidance was between 400,000 and 410,000 ounces)

This graphic from B2Gold's presentation gives a good picture of the company's production profile and growth.

On the chart, one would expect an increasing price in 2018 with such strong growth and it did start out well going to $3.25. However, it has now given back all those gains and has come back to a strong support level between $2.00 and $2.20 that has been tested a few times in the past.

B2Gold is too low priced to be bother with options. You might as well just buy the stock.

Alamos Gold Inc. (AGI:TSX; AGI:NYSE), Recent Price $5.77
Opinion: Stopped out at $6.20, Buy back

Since the acquisition of Island Gold in November 2017, mineral reserves and resources have continued to grow:

  • Proven and Probable mineral reserves have increased 365,000 ounces before mining depletion, or 207,000 ounces, net of mining depletion of 158,000 ounces since the start of 2017. Mineral Reserve grades have increased 17%.
  • Measured and Indicated mineral resources have increased 142%, or 130,000 ounces.
  • Inferred mineral resources have increased 18%, or 184,000 ounces.

"Island Gold continues to grow in both size and quality. In the nine months since we acquired Island Gold, Mineral Reserves and Resources have grown in all categories while Mineral Reserve grades have increased 17%. As 2018 drilling unfolds, we see excellent potential for this growth to continue," said John A. McCluskey, president and CEO.

On July 25, Alamos was granted the GSM (business opening and operation) permit required for the development of its Kirazli project by the Canakkale governorship in Turkey. Alamos now has all the required permits to ramp up full-scale construction activities.

"As one of the lowest-cost and highest return gold projects in the world, Kirazli will be a significant driver of free cash flow growth with initial production expected in 2020," said John A. McCluskey, president and chief executive officer.

As outlined in the 2017 feasibility study, Kirazli has a 44% after-tax internal rate of return and is expected to produce over 100,000 ounces of gold during its first full year of production at mine site with all-in sustaining costs of less than $400 per ounce. This is expected to bring consolidated production to over 600,000 ounces per year while significantly lowering the company's cost profile.

This slide from the company's presentation highlights the strong growth in cash flow:

Analysts on average target the shares at $11.32. "We continue to view Alamos as a preferred name in the mid-tier space, with the bulk of its production sourced from projects with well-established mine lives in low-risk jurisdictions and funded growth opportunities on the horizon."-Raymond James analyst Tara Hassan.

The stock chart looks much the same as other gold stocks, down to new lows and in this case to the resistance level going back to 2015.

The stock is priced too low for US$ Call options, but on the Canadian side the April 2019 $5 Calls at $1.20 are worth considering. They are currently $0.77 in the money.

Ron Struthers founded Struthers' Resource Stock Report 23 years ago. The report covers senior and junior companies with ample trading liquidity. He started his Millennium Index of dividend stocks in 2003 - $1,000 invested then was worth over $4,000 end of 2014 and the index returned 26.8% in 2016. He retired from IBM after 30 years in customer service, systems and business analyst, also developing his own charting software. He has expertise in junior start-ups and was a co-founder of Paramount Gold and Silver.

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Disclosure:
1) Ron Struthers: I, or members of my immediate household or family, own shares of the following companies mentioned in this article: B2Gold, Kinross. I personally am, or members of my immediate household or family are, paid by the following companies mentioned in this article: None. My company currently has a financial relationship with the following companies mentioned in this article: None. I determined which companies would be included in this article based on my research and understanding of the sector.
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Charts and images provided by the author.

Struthers' Resource Stock Report Disclaimer:
All forecasts and recommendations are based on opinion. Markets change direction with consensus beliefs, which may change at any time and without notice. The author/publisher of this publication has taken every precaution to provide the most accurate information possible. The information & data were obtained from sources believed to be reliable, but because the information & data source are beyond the author's control, no representation or guarantee is made that it is complete or accurate. The reader accepts information on the condition that errors or omissions shall not be made the basis for any claim, demand or cause for action. Because of the ever-changing nature of information & statistics the author/publisher strongly encourages the reader to communicate directly with the company and/or with their personal investment adviser to obtain up to date information. Past results are not necessarily indicative of future results. Any statements non-factual in nature constitute only current opinions, which are subject to change. The author/publisher may or may not have a position in the securities and/or options relating thereto, & may make purchases and/or sales of these securities relating thereto from time to time in the open market or otherwise. Neither the information, nor opinions expressed, shall be construed as a solicitation to buy or sell any stock, futures or options contract mentioned herein. The author/publisher of this letter is not a qualified financial adviser & is not acting as such in this publication.

c. Copyright 2018, Struther's Resource Stock Report

( Companies Mentioned: AGI:TSX; AGI:NYSE, BTG:NYSE; BTO:TSX; B2G:NSX, G:TSX; GG:NYSE, K:TSX; KGC:NYSE, )

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