Will Higher Rates Keep Gold Down?
It’s still not a bull market yet, but gold just posted its best week since late August as investors have begun to realize that inflation isn’t going away any time soon.
The yellow metal price was up sharply last Thursday after the release of the U.S. retail sales report for September, which showed a 0.7% improvement from the previous month—well above consensus expectations. The bullish report was driven by both higher consumption and higher wholesale prices.
Meanwhile, in the bond market, longer-dated Treasury prices took a hit, which led to the 10-year Treasury Yield Index (TNX) rising nearly 4% late last week in a further sign that inflation pressures are increasing.
Many investors consider rising Treasury yields to be a major impediment for gold prices, and indeed this is normally true since higher yields increase the opportunity cost of holding non-yielding bullion. But gold is first and foremost a safe-haven asset, and as we’ve talked about in past reports, its strongest performances have historically occurred against a backdrop of sustained inflation.
An example of this would be the period from roughly 1977 through 1980, when the U.S. inflation rate reached one of its highest levels in decades. During those years, gold prices rose by an eye-popping 400%. Yet the U.S. 10-year Treasury yield was also steadily rising at that time, gaining 86% during the same 3-year period.
The lesson here is that when inflation is “red hot” and increasing at an ever-accelerating pace, investors at some point lose their excessive focus on yield and begin to worry about maintaining the value of their money. That’s when gold finally comes into its own and safety-related demand explodes while investors recognize the asset protection it affords (while at the same time the soundness of government debt increases begins to be questioned in a super-inflationary environment).
Thus, rising gold prices aren’t entirely inconsistent with rising Treasury bond rates. That said, we obviously haven’t yet reached the point where inflation is a serious enough concern that investors are willing to sacrifice the relentless pursuit of higher yields for absolute safety. Until that time is reached, gold will likely remain periodically subject to the buffeting winds of rising yields.
A couple of things likely need to change in order to increase the market’s perception of the inflation threat. One is for the U.S. dollar index (USD) to show some persistent weakness to drive home just how much gold’s currency factor has improved.
The other improvement needed is for risk tolerance to decrease. Right now, investors are still enamored with equities, cryptocurrencies and other risk assets. This can be seen in the following graph of the Grayscale Bitcoin Trust (GBTC), which is on the upswing as investors are currently more concerned with capital appreciation than with capital preservation. This is undermining gold’s short-term “fear factor” and is another major reason why the metal has been unable to gain any meaningful upside traction in recent months.
In the meantime, super-abundant liquidity and bank reserves, high levels of federal spending and lingering supply chain disruptions should contribute to inflation’s persistence. And at some point, increasing wholesale and retail prices will convince investors that it’s time to seek capital preservation. And that’s when gold will finally come into its own.
Updates
Alcoa (AA) is one of the world’s largest aluminum producers, and as such stands to benefit from the persistent strength in the global aluminum market. Its operations include bauxite mining (aluminum ore), alumina refining (for smelting) and the primary aluminum manufacturing. With aluminum prices at 10-year highs, Alcoa is expected to see significantly higher free cash flows going forward. This is a big reason for the recent strength, especially after a string of high-profile institutions upgraded the company. Another reason for the optimism is the anticipated increase in automotive demand for the metal going forward. On the financial front, Alcoa released a stellar third-quarter report last week featuring some record metrics and a massive earnings and revenue beat. Q3 net income of $337 million was driven by 10% growth in revenue. Alcoa generated $3.1 billion in revenue in Q3 (up 44%), driven by higher alumina and aluminum prices. Alcoa also generated $352 million in free cash flow and finished the latest quarter with around $1.5 billion in cash. The company also reinstated its dividend for the first time since 2016. On September 7, I recommended using pullbacks to buy a half position in AA, using an initial stop-loss placed slightly under the 40 level. Let’s take some profit in AA after last week’s stellar 22% gain, while raising the stop-loss on the remaining position to slightly under 50. HOLD
Alliance Resource Partners (ARLP) is a metallurgical coal mining complex operator with approximately 1.7 billion tons of coal reserves in Illinois, Indiana, Kentucky, Maryland, Pennsylvania and West Virginia, making it the second-largest coal producer in the eastern U.S. Alliance produces a diverse range of metallurgical coal with varying sulfur and heat contents, enabling the company to satisfy the broad range of specifications required by steelmaking and thermal customers. The company also generates royalty income from mineral interests in premier oil and gas producing regions in the U.S., primarily the Anadarko, Permian, Williston and Appalachian basins. Analysts project revenue growth in the high teens for the next two quarters. A 3.4% dividend yield is an added bonus. Participants last week bought a conservative position in ARLP; I recommend using a level slightly under 10.50 (closing basis) as the initial stop-loss for this position. Earnings are due out October 25. BUY A HALF
With tin remaining in a position of strength, I recently placed Alphamin Resources (AFMJF) on a buy. Mauritius-based Alphamin explores and develops mineral properties and is a low-cost producer of tin concentrate from its high-grade deposit, Mpama North, part of the Bisie Tin Project in the Democratic Republic of Congo. (Mpama North is the world’s highest-grade tin resource—about four times higher than most other operating tin mines in the world—allowing Alphamin to produce 3% of tin produced globally.) Alphamin also mines and sells tin from its North Kivu mine, producing nearly 10,000 tons of tin annually. While Alphamin is recognized as a promising tin producer, it flies largely under the radar among mining stock analysts right now. Total revenues for 2021 are projected to be around $310 million, up 66% from a year ago. Participants purchased a conservative position in AFMJF on October 7 using a level slightly under 58 cents as the initial stop-loss. After its latest 12% rally, I suggest taking a bit of profit, raising the stop to slightly under 65 cents. HOLD
With our favorite gold-tracking ETF, the GraniteShares Gold Trust (BAR), showing signs of life last week, I recommended doing some nibbling in the event gold prices surge ahead in the coming weeks on mounting inflation fears. To that end, participants purchased a conservative position in BAR on October 13 using a level slightly under 17.35 as the initial stop-loss (intraday basis). Hold for now. HOLD
I also placed the ADR for Glencore PLC (GLNCY) on a buy last week after its recent show of strength. Glencore is the well-known multinational commodity trading and producing firm, with exposure to oil and gas, minerals like coal, ag commodities and metals like copper, zinc and nickel. In other words, it’s an across-the-board natural resource play and, as such, allows investors to capitalize on broad commodity market strength. Recent strength in the energy sector is responsible for much of Glencore’s outperformance vis-à-vis more metal-focused stocks, but its industrial metals business is also doing well. (Glencore’s CEO recently told the Qatar Economic Forum that world copper supplies need to double by 2050 in order to meet the growing demand for renewable energy, and the firm is well positioned to benefit from this demand explosion.) Analysts anticipate 47% revenue growth for the full year. Participants bought a conservative position in GLNCY last week using a level slightly under 8.75 as the initial stop-loss. I suggest raising the stop-loss to slightly under 9.50 (closing basis) after the strong rally in the last few days. BUY A HALF
Livent Corp. (LTHM) is the largest U.S. lithium-only miner, providing a range of lithium-based products and serving the EV, chemical, aerospace and pharmaceutical industries. Revenue and earnings projections for Livent are strongly optimistic for the next several years, with analysts expecting top-line growth of 34% this year and around 20% next year, while earnings are projected to grow at an even faster pace. Participants on October 13 bought a conservative position in LTHM using a level slightly under 22.25 as the initial stop-loss. BUY A HALF
On the copper front, we recently added Taseko Mines (TGB) after last week’s breakout above the 2 level (per instructions in our previous update). Canada-based Taseko is known mainly for being a mid-tier copper miner that operates the Gibraltar Mine, Canada’s second largest open-pit copper mine. Taseko produces more than just copper, though, and the Gibraltar mine boasts proven reserves of 53 million pounds of molybdenum. Located in south-central British Columbia, Gibraltar has an estimated 18-year mine life and is located in a mining-friendly, low-risk jurisdiction. Total molybdenum production for the company in the second quarter of 2021 was 402 thousand pounds. Taseko reported that molybdenum prices strengthened in Q2 and averaged $14.32 per pound (27% higher sequentially). Copper production for Q2 was 20% higher from a year ago, while cash flow from operations was $72.5 million (nearly double from a year ago). Things are expected to strengthen for the firm moving forward. Management said the current copper price and expected production growth is supportive of improved financial performance at the Gibraltar mine over the remainder of 2021. All told, we think Taseko has turnaround potential and has established a nice-looking base in recent months from a chart perspective. Earnings are due out October 28. BUY A HALF
Teck Resources (TECK) is one of the world’s largest copper producers and is also the second-largest seaborne exporter of coking coal, with four operations in Western Canada and significant high-quality steelmaking coal reserves. Going forward, Teck plans to double its copper production in the next two years, seeing demand for the metal dramatically increasing from the white-hot electric vehicle industry. A major Wall Street institution agrees, estimating Teck’s copper production will more than double from its “transformational” QB2 project (one of the world’s largest underdeveloped copper resources) in top producer Chile. Providing additional support for Teck’s copper strength is news that copper stocks in top consumer China hit their lowest levels since 2009, with London Metal Exchange inventories falling 27% last week. Analysts see the firm’s revenue jumping 68% in both Q3 and Q4, with earnings growth accelerating. Investors did some nibbling in TECK last week using a suggested initial stop-loss slightly under 24. I now suggest raising the stop to slightly under 26 on a closing basis after last week’s rally. BUY A HALF
New Positions
As governments around the world push ahead with decarbonization plans, uranium-based nuclear power is becoming increasingly embraced as a key fuel source. One industry player in particular that is showing promise from an intermediate-term standpoint is Denison Mines (DNN), a Canada-based uranium exploration, development and production company. Denison’s flagship project is Wheeler River, which has two high-grade uranium deposits, Phoenix and Gryphon. Phoenix is believed to possess the lowest production costs of any undeveloped uranium deposit, with all-in sustaining costs of $8.90 per pound (compared with current prices of around $32) and operating costs of just $3.33 per pound. All-in sustaining costs for Gryphon, meanwhile, are also a below-market $22.82 per pound, with a combined 109 pounds of probable reserves and a 14-year mine life. Additionally, Denison recently agreed to acquire a 50% stake in the JCU Exploration Company from UEX Corp. JCU holds a portfolio of 12 uranium project joint venture interests in Canada, and the acquisition is expected to allow Denison to not only increase its indirect ownership of its flagship Wheeler River project, but also to expand its asset base to include additional important Canadian uranium development projects such as Millennium and Kiggavik. Denison is admittedly speculative, but with physical uranium supplies getting tighter thanks to the recent decision of the world’s largest uranium producer, Kazatomprom, to limit production in 2022 and 2023—and with the Sprott Physical Uranium Trust Fund gobbling up uranium on the spot market— the stock looks to be in a good position to continue a turnaround that began last year.
What to Do Now
Investors can purchase a conservative position in DNN here using a level around 1.40 as the initial stop-loss on a closing basis. BUY A HALF
Portfolio
| Stock | Price Bought | Date Bought | Price 10/19/21 | Profit | Rating |
| Alcoa (AA) | 45 | 9/7/21 | 55 | 22% | Hold |
| Alliance Resource Partners (ARLP) | 12 | 10/13/21 | 12 | 0% | Buy a Half |
| Alphamin Resources (AFMJF) | 0.73 | 10/8/21 | 0.78 | 7% | Hold |
| Dennison Mines (DNN) | New | - | - | - | Buy a Half |
| Glencore PLC ADR (GLNCY) | 9.64 | 10/8/21 | 11 | 9% | Buy a Half |
| GraniteShares Gold Trust (BAR) | 18 | 10/13/21 | 18 | -1% | Hold |
| Livent Corp. (LTHM) | 26 | 10/13/21 | 26 | 2% | Buy a Half |
| Taseko Mines (TGB) | 2.05 | 10/12/21 | 2.28 | 11% | Buy a Half |
| Teck Resources (TECK) | 28 | 10/12/21 | 29 | 6% | Buy a Half |
Buy means purchase a position at or around current prices.
Buy a Quarter/Half means allocate less of your portfolio to a position than you normally would (due to risk factors).
Hold means maintain existing position; don’t add to it by buying more, but don’t sell.
Sell means to liquidate the entire (or remaining) position.
Sell a Quarter/Half means take partial profits, either 25% or 50%.