US debt ceiling negotiations put spotlight back on gold

• Precious metal feels unloved even as government debts spiral
• US debt ceiling negotiations could raise metal’s profile
• Latest major gold deal suggests UK gold producers could be cheap

“Gold haters may be perplexed to see the precious metal holding firm above $2,000 an ounce even as the US inflation rates cool, but gold bugs will point to the ever-growing US federal deficit and how the debate over the debt ceiling is warming up on Capitol Hill,” says AJ Bell investment director Russ Mould. “The US Treasury Department has already acknowledged that the deficit for the first half of fiscal 2023 alone is $1.1 trillion, so its forecast of $1.4 trillion for the year to September looks optimistic. While the US will not default, it will keep raising the debt ceiling and possibly have to print more money so it can do so, especially as interest bills on the borrowing are going up. More debt ultimately begets more debt.

Source: FRED - St. Louis Federal Reserve database, US Treasury department estimates, Refinitiv data

“House of Representatives Speaker Kevin McCarthy and the Republicans are pressing for agreements on budget cuts as part of a deal to agree on a new debt ceiling, while President Biden and the Democrats do not seem keen on any strings being attached to any deal. This is understandable given the Democrats’ planned welfare and green investment programmes, as well as the approaching Presidential election in November 2024.

Source: Refinitiv data, FRED - St. Louis Federal Reserve database

“Gold bugs will on the look-out for any signs of higher spending and higher deficits as justification for their faith in the precious metal as a store of value at a time of fiscal incontinence and after an extended period of money printing. The US Federal Reserve, Bank of England and European Central Bank are trying to stick with Quantitative Tightening and sterilise some of the trillions they conjured out of thin air in the wake of the Great Financial Crisis, the European Debt Crisis and the COVID-19 outbreak. But financial markets are already showing the strain of that after blow-ups in cryptocurrencies, gilts and banks, to name but three, and the shadow of recession still hangs over the globe.

“How far they get before they have to halt QT (and even return to QE) remains a point for debate, but in 2022 central banks themselves globally bought the most amount of gold since 1967 at 1,136 tonnes according to the World Gold Council, which may be a clue.

“Fans of gold will also point to Newmont Corporation’s decision to increase the value of its all-stock offer for fellow gold digger Newcrest Mining.

“Whenever a major piece of M&A (merger and acquisition) activity is announced, the single most important items of information are the price paid and the valuation implied. This is because they can determine whether the buyers or potential sellers are getting the better part of the deal and also whether the shares of peers in the same industry or sector are looking cheap or not.

“The gold mining industry has been busy in this respect. Barrick Gold swallowed up Randgold Resources and Newmont snapped up GoldCorp in 2019, while Agnico-Eagle and Kirkland Lake Gold merged in 2021 and Agnico-Eagle and Pan American Silver have just finished buying and divvying up Yamana Gold. Among the few remaining UK gold miners, Chaarat Gold took a look at last Shanta Gold (SHG:AIM) last autumn and although nothing came of that it did suggest that someone, somewhere thought there was value on offer.

“Sceptics will dismiss this as an attempt to manufacture growth and momentum where little or none exists, since gold output only grows slowly and the all-in sustained cost (AISC) of producing gold is rising, in no small part due to surging energy and staff costs (trends which rather dent gold miners’ perceived status as a hedge against inflation).

“Gold bugs, however, will argue that the proposed Newmont-Newcrest deal is simply further evidence that gold company executives see value that the stock market is overlooking. The price of gold is up by 32% since the start of 2020 but the NYSE Arca Gold Bugs index, known as the HUI, is up by just 9% over the same period – and all of that gain (and more) from the index hails from the rally seen since 1 January this year.

Source: Refinitiv data

“American gold miner Newmont is now getting busy again. It first bid for Australia’s Newmont in February in an all-stock deal that valued the target at $17 billion. The would-be buyer has now increased its all-paper offer to $19.5 billion.

“That price tag puts Newcrest on almost 1.7 times historic book, or net asset value. The major US-listed producers trade on 1.5 times and the London market’s gold diggers at 1.1 times.

Source: Company accounts, Marketscreener, consensus analysts’ forecasts. *Based on Newmont bid offer of $19.5 billion.

Source: Company accounts, Marketscreener, consensus analysts’ forecasts. *Based on Newmont bid offer of $19.5 billion.

“In many cases, the US-listed miners and producers do look to offer greater scale (and lower all-in sustained production costs) than their UK-listed equivalents, but the relative valuations do look to reflect at least partly that and also the differing jurisdictions in which the miners operate. It is also possible to argue that junior miners can offer greater leverage into any upside in gold prices.

“Not everyone will be convinced. Many will share Warren Buffett’s opinion that gold is an inert, useless lump which an alien invader would dismiss as worthless were they to trip over an ingot upon their arrival from outer space. At best, those in agreement will be prepared to accept that gold could be worth what it costs to get it out of the ground – around $1,200 an ounce, based on the all-in sustained cost (AISC) at the world’s largest quoted gold miner, Newmont Corporation.

“That is some 40% below the current gold spot price and may explain to some degree why gold has underperformed equities so badly, even if inflation has been surging and debt has been rising.

“Bulls will counter by saying that this is where the opportunity lies. Gold is trading toward the lower end of its range relative to global equities (as benchmarked by the FTSE All-World since its inception in 1994) while gold miners are trading at near-historic lows relative to the metal’s price (as benchmarked by the HUI and its inception in 1997).”

Source: Refinitiv data