Just before Trump came to power, gold dramatically rose 4% to US$1316 per oz. It soared as gold investors bailed out of stocks world-wide. Trump’s policies, such as imposing tariffs on China and limiting immigration, were reported as reasons to back gold.
But then investors reversed course; Trump’s pledge to cut taxes, reduce regulation, and increase military and infrastructure spending created a Trump rally. US markets reached record highs and the price of gold retreated, bottoming out around $US1128 on 15 December.
As of 9 February, the price of gold in the US had rebounded to $1235, intraday, an increase of 9.5% over the December low. On 16 December in Australia, the top five ASX gold producers rebounded strongly - up as much as 47%.
Today, the Trump Rally appears to be stuttering. The question is why?
The potential policy changes from the new administration include the following:
• Lowering the regulatory burden on small businesses and opening public lands and other measures to increase drilling for shale oil and gas.
• Major spending increases on infrastructure and in military hardware.
• Revising the US Tax Code to lower corporate and individual tax rates.
In addition to the flap over immigration restrictions, there are other issues halting a further rally:
1. Increased US protectionism can lead to trade wars.
2. Although Trump’s Republican Party has a solid lock on the US Congress, his spending initiatives could meet oppositiion from members of his own party.
3. Trump’s ideas for tax reform may be at odds with Republican leadership in the US Congress.
In the eyes of many, cutting the corporate tax rate in the US would result in the biggest boost to US GDP. And Trump told markets that he expects to announce something over the coming weeks. US markets once again rallied, with the DJIA rising 115 points on the day of Trump's announcement, posting yet another record close. The price of gold dropped to $US1229.40
While good news for believers in the rally, skeptics can point to the potential for negative reactions should the Trump tax plan fall short or face opposition in the US Congress.
Gold has rallied in the face of all this, with concerns over upcoming European elections fueling the fire. Increased uncertainty bodes well for the precious metal and those who mine it.
Let’s take a look at the price action of the top five gold miners on the ASX.
While all five have sustained healthy share price increases since the 2015 lows and year over year as well, the top four all have two year earnings growth forecasts in excess of 20% and five year expected Price to Earnings Growth (P/EG) Ratios under 1.0.
When differentiating stocks in similar businesses with an eye towards investing in the best in breed, many investors rely on the Price to Earnings Ratio (P/E). This ratio relies strictly on past measures – the latest earnings per share reported and the current price of the stock. The P/EG adds projected earnings growth, either one year (current) or five years, into the calculation. In short, the P/EG has a forward looking component to it and in the minds of many is a fuller measure of a stock’s value. For value investors, a P/EG of 1.0 indicates the stock is fairly priced. Anything under 1.0 could be a bargain. Generally speaking, high growth stocks will have higher P/EGs but that is not the case with the top four ASX gold miners. The following table looks at valuation measures, historical price performance, and another important measure for evaluating gold stocks – the All in Sustaining Costs, or ASIC.
Evolution Mining (EVN) appears to be the rising star here, while Northern Star Resources (NST) has posted the best performance in terms of shareholder return. The current average P/E for the Materials Sector, in which the gold miners are a subset, is 13.92, while the current P/EG is 0.50. The one-to-one comparison here is problematic as the overall Materials Sector includes a wide range of company businesses including chemicals, construction materials, glass, paper, forest products and related packaging products. However, Metals and Mining companies make up the majority of companies in the Sector.
Note that all of these companies have AISC well below the current price of gold. OceanaGold (OCG) reports Full Year Earnings shortly so we have substituted the company’s estimate for FY 2017. All in Sustaining Costs is a more accurate cost measure than the previous “Cash Cost” method of reporting which did not include ancillary expenses incurred by a mining company including other expenses such as general office spending and capital expenditures on mine development and maintenance.
In theory any of these top miners could be a good investment, based on future forecasts. In practice, however, the price action of gold and stocks over the last few months flies in the face of generally accepted conventional investing wisdom. Specifically, stocks and gold should not both be going up at the same time.
Gold bulls might argue there is nothing conventional about what is going on in the United States. It seems some investors have been ignoring warnings signs and buying stocks in the hope Trump will lead the US economy to new heights.
The price of gold is driven by fear and uncertainty. The chairman of our largest gold miner, Newcrest Mining acknowledged that uncertainty about President Trump’s policies are driving up the price of gold, but “the effect may be limited to the short-term only.”
On 6 February Bloomberg released the following graph that tracks usage of the word “uncertainty” in media stories.
The Chicago Board Options Exchange (CBOE) maintains the respected volatility index, or “VIX” that tracks investor fear. Conventional wisdom, disputed by some experts, says that when the VIX is rising, the price of gold should follow. However, the VIX in the last month or so is not following conventional wisdom. As an alternative measure of uncertainty and fear Bloomberg compared the VIX against another index --the Global Economic Policy Uncertainty Index.
The Index tracks common terms associated with policy issues and political implementation by looking back at the 10 leading US newspapers going back to 1985. The results showed a spike in the Index during each economic and political crisis going back to 1985 and the use of the Index has expanded to different countries and globally as well.
The following graph suggests that while the investing community as a whole remains calm, policy makers and politicians are getting increasingly nervous.