(Kitco News) - A stronger U.S. economy may mean some initial headwinds for gold but that also means the metal is likely to draw support whenever more robust growth translates into inflation, said the portfolio manager of a major gold mutual fund.
Dan Denbow, of the $1 billion USAA Precious Metals and Minerals Fund (USAGX), said mining companies are becoming “leaner and meaner” as they focus on profitable projects that return capital to shareholders. But as they cut back on spending for more marginal projects, this is likely to lead to reduced supplies in a few years that will be supportive for gold, he continued. That in turn could make it stock selection more important for investors in the mining sector.
In an interview with Kitco News, Denbow also said he does not expect a “flood” of mergers and acquisitions since there are limited properties such as the Canadian Malartic mine that was the key asset in a major acquisition in the news this week.
Gold lately has tried to establish a base in roughly the $1,300 to $1,325 area, Denbow said. Prices have dipped below but been able to recover. There has been some volatility based on expectations for Federal Reserve monetary policy and uncertainty about the economy of China, which last year became the world’s No. 1 gold buyer, Denbow said.
Most economists look for the U.S. economy to pick up, blaming weakness in some of the early-year data on an unusually cold winter. An economic pickup would be a “double-edged sword” for gold, Denbow said.
“The natural assumption is if the economy strengthens, rates will rise and the dollar will be stronger,” he said. “And … that would prove to be a headwind for gold. That is a logical conclusion.
“On the flip side, though, is how fast are we (the economy) strengthening in terms of job market pressure and does that bring about inflation faster than people were expecting?”
Inflation is benign so far, he said. But, “if we do see some unexpected inflation, that’s where you would see a positive surprise for gold prices,” he said.
Denbow said the market seems to have largely already factored in an expectation for a modestly improving economy this year, with continued tapering of the bond-buying program known as quantitative easing and a hike in short-term interest rates sometime next year.
“It’s a change in that expectation that will impact gold prices either up or downward,” he said.
If gold prices stabilize and hold the roughly $1,300-$1,325 area, Denbow said, gold-mining stocks are likely to outperform the yellow metal itself. He cited the move by companies toward optimizing profits rather than the race to hike production a few years ago.
“They are getting leaner and meaner, making sure the capex (capital expenditures) is focused on … projects with a decent return outlook rather than some of the more marginal projects,” he said. This would increase the attractiveness of mining shares. Additionally, non-traditional gold investors would be more comfortable stepping into mining shares if they see the price of the yellow metal holding up, Denbow added.
More Cost-Cutting Efforts Expected From Producers
Companies have highlighted cost-cutting efforts in their earnings reports in recent quarters, and Denbow looks for producers to continue with the belt tightening.
“It just started and it takes a long time to work through and change behaviors and get through the budgeting processes,” he said. By the end of the second quarter, he said, investors should have a stronger handle on where operating costs will have stabilized.
At first blush, he said, first-quarter earnings from producers – due out over the next few weeks – might look weak since they are typically year-on-year comparisons and gold prices fell since the first quarter of last year. However, Denbow said, they should be “fairly good” sequentially when compared to the third and fourth quarters.
For starters, gold prices rose in the first quarter and companies have been trying to cut mining costs. Also, many companies in recent quarters already incurred large write-downs as the fall in gold prices last year hurt the value of their reserves, meaning the next round of earnings reports should be “cleaner” with less of these write-downs, Denbow said.
“There probably still will be some…but most of them should be done,” he said. And there should be even less of this so-called “noise” in second-quarter results to be announced this summer, he added.
Denbow outlined possible longer-term impacts of company efforts to cut back on projects and capital expenditures.
“At some point, that’s going to have an impact in terms of the mine supply,” he said. Presumably, this will mean less new projects coming on line, and less supply is supportive for any commodity whether it be gold, wheat or crude oil. So less output three to five years down the road should be constructive for gold prices, Denbow said.
But the picture would be more complicated for the mining sector, since profits are helped by higher gold prices but hurt when companies have less gold to sell.
“For those that do have projects that come on (line) and are very good, that will be positive for them,” Denbow said. “It will make stock selection probably fairly critical at that time – finding those companies that still have things to bring to the table and allow them to … at a minimum to sustain production and also grow production at a time when the lack of new mine supply should be supportive of gold prices.”
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On another subject, Denbow said companies are likely to be opportunistic when pursuing any further mergers and acquisitions in the mining sector.
One such deal was announced Wednesday when Agnico Eagle Mines Ltd. (TSX:AEM) (NYSE:AEM) and
“I don’t think we’ll have a flood of them (mergers). I think we’ll see where they’ll be done opportunistically,” Denbow said. “The Canadian Malartic mine itself is a very nice asset. It’s not often that you can pick up an asset of that size with that cash-flow potential.”
He later added, “the problem is that there are not that many Canadian Malartics out there to be purchased,” making it harder for other producers to undertake such deals.
By Allen Sykora of Kitco News; asykora@kitco.com
