The bull market in gold is just getting started

John Deniz

Paragon Funds Management

US$ gold has broken its previous record of US$1,921/oz (6th of Sept 2011) by closing July at a new all-time high of US$1,976/oz. A$ gold has also just broken record highs, trading at A$2,776/oz. Silver broke 7-yr highs by closing the month at US$24.39/oz, being pulled up by gold.

6 key drivers for gold strength to continue:

  • US 10-yr bond rates fell to 0.55%, their lowest monthly close in history.
  • US real rates continued to fall to new cycle lows to -1.0%, falling below the previous post-GFC Sep 2011 cycle low.
  • The US budget deficit totalled US$2.7t in the first nine months of the US FY20, ~3x as big as the shortfall registered for the entire previous year.
  • July saw further significant stimulus of US$1t by the US and €750b by the EU. Unprecedented and historic US fiscal and monetary stimulus, combined with a surging Fed balance sheet, ballooning US twin deficits and record government debt - not seen since the post-1940’s war era – in time is likely to create an inflation problem.
  • Global liquidity (M2 money supply) has gone vertical - up >20% CYTD!
  • Finally, the US$ index has given way, falling 10% since March to 93.35c and new 2+ yrs lows on increasing US$ debasement fears.

The biggest gold bull cycles (in pink below) occurred when US real rates went negative (note US real rates fell to -6% in 1979). Just like the Nov 08 – Sep 11 gold bull market, today’s weight of money is seeing gold ETF inflows rising and starting to outpace S&P 500 ETF inflows. The current gold cycle (in yellow below) continues to boast strong upside risk.

OceanaGold is currently our largest position, having entered at near recent lows. Whilst a gold stock, it’s also a classic turnaround story, soon to be net cash, unhedged, with enviable self-funded organic growth - providing long-life, high-margin production and strong free cashflows. Up until the last 12 months, OceanaGold had 7 consecutive years of delivering or exceeding guidance. A US hurricane (freak rainfall impacting its Haile asset), Philippine interim ban (politics impacting Didipio) and COVID-19 (forced shutdown of their NZ operations) hit them hard, impacting their impeccable track record of delivery. All assets are now turning around.

Despite being a $2.3b large-cap, it's trading on a mere EV/CY21F FCF of ~4.5x based on spot gold (as will be unhedged from 1/1/21) and assuming Didipio ramps up from 1Q21. In comparison, its Aussie gold peers are trading on ~15x CY21F FCF. Even without Didipio, OceanaGold is trading on EV/CY21F FCF of <8x. OceanaGold is very well placed to go up 2-3x inside the next 2 yrs.

Adriatic Metals is advancing its Vares polymetallic project (~50% precious metals - more so silver) with exceptional economics, and in our view, is the highest quality silver exposure on the ASX. Sandfire Resources (with <2.5yrs mine life remaining at its flagship Degrussa mine) is clearly pursuing Adriatic which is the best development option within its growth asset mix. Sandfire has accumulated a 16% interest in Adriatic and using desperate efforts to acquire more. Corporate interest is a given, although our preference would be to see Vares built by Adriatic as its unrisked valuation offers multiples on the current share price over the medium term.

USD down-cycles have typically fuelled material gains in precious metals, small-caps and resources. This is where Paragon has proven capability. Metals already in or approaching deficit markets like copper, nickel, lithium and uranium should do particularly well. Excess inventories can unwind in the short-term, setting the scene for significant bull markets in these metals. Finally, growth equities continue to look attractive relative to very low (or negative) bond and cash rates. We remain very excited by the opportunity set and see the next 2 years to be like 2009 and 2010.

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John Deniz
Chief Investment Officer
Paragon Funds Management

John co-founded Paragon in 2012 and became principal and majority shareholder from 2017. John is responsible for executing the investment strategy and managing the Paragon Australian Long Short Fund. John has had 16 years in financial markets,...

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