While the press euphorically announced that economic growth in the fourth quarter of last year was better than expected (because: 2.9% growth in 2018), post-crisis economic growth has been among the most disappointing in history. Now that we have an estimate for the fourth quarter, the sad but true conclusion must be that the U.S. is setting an extremely upsetting record: 13 years in a row with annual GDP growth below 3%. All this despite Trump’s election promise to grow the U.S. economy at a faster rate than 3%.
What was surprising from the BEA’s latest GDP release was the fact that (private) inventories have increased considerably. This points to three different possible conclusions:
1. Businesses are afraid that the trade war escalates even further and are therefore willing to – as long as they can – build inventory without any trade restrictions;
2. Businesses have invested in new inventory but that investment was not met with an equally high demand (thus, inventories accumulate);
3. Businesses are remarkably optimistic with regard to the economic outlook and future demand and are investing in inventory even though demand has not picked up yet.
Explanations one and two would point toward lower growth later this year, while explanation three would point toward higher growth this year. Also remember that economic growth in virtually every year since the Great Recession has consistently disappointed in the first quarter (which would mean that growth falls back even further).
Even though we have paid little attention to gold mining so far, you might have read about it elsewhere. The gold mining sector is busy consolidating. Last week on Monday, Barrick Gold Corp. announced a bid (in shares, not cash) of $17.8 billion dollar on rival Newmont. In January, Barrick already acquired Rangold from South-Africa. To complete the circle, Newmont also tried to buy Gold Corp Inc in January, with an offer north of $12.5 billion dollars.
This comes to show some important drawbacks of investing in gold mining stocks instead of the underlying physical metal.
Assume for a moment that you’re buying a gold mining stock. It might be that it looks cheap, both with regard to its current production levels and with regard to a (possibly) higher gold price in the future. You buy the stock, but the market – at least, initially – disagrees with you. Say, this rather volatile gold mining stock drops 25%. Fine, you might say, I now have a paper (unrealized) loss. But I will be patient and wait until my investment thesis becomes reality and the stock readjusts upward. At that point in time, I will have a paper (unrealized) gain and I would be able to easily turn this paper gain into a realized gain by selling my shares.
This might sound reasonable, until Newmont or Barrick sabotages your little plan by buying out your gold mining company against a – according to you – ridiculously low price or steep discount. What could you possibly do? Very little. Your unrealized paper loss is, in essence, realized by the acquisition. After the acquisition, you could of course buy shares of another gold mining company. But it could easily be the case that you end up with (a) a realized loss and (b) a stock which you would have never bought to begin with (because: not so cheap).
Of course, such a consolidation of the gold industry does not directly affect your physical holdings of gold.
A possible merger between Newmont and Barrick, which might be in the cards, would result in – by far – the largest gold producer in the world, but markets did not react very positively on the news. Newmont fell by a percent, whereas Barrick dropped three percent as a consequence of the possibility of further consolidation as mentioned in the press.
Jim Grant wrote the following with regard to this most recent merger proposal between gold’s two biggest giants:
Mark Bristow, former CEO of Rangold and current Barrick boss, shared his perspective in a Jan. 2 interview with Bloomberg: “[The] industry, if it had carried on the way it was, was going to become irrelevant, [with] too few assets with too many management teams and it needs reorganization.”
The matter at hand for investors: Will a wave of corporate consolidation help streamline production, increase operational efficiency and pave the way for higher share prices? Or do the low- or zero-premium prices being bid for these large mining assets foreshadow more disappointing days ahead?
Grant’s today put the question to John Hathaway, the co-manager of the Tocqueville Gold Fund, who anticipated a wave of industry consolidation at the Spring 2018 Grant’s conference. Hathaway believes that the proposed Barrick-Newmont combo faces an uphill battle, as “its hard to see where the value creation is coming from” in a $42 billion merger of equals while “the gold mining industry doesn’t necessarily lend itself to that kind of scale.”’
In other words: a consolidation will not result in economies of scale at all.
Moreover, the prices offered for various gold mining companies are not particularly enticing. This means that the industry apparently anticipates that gold prices will not rise for the foreseeable future or the coming years.
One small comfort: industry experts are seldom right about these types of predictions. And industry consolidations are often a green light for a renewed bull market. Let us assume – on a positive note – that this will be again the case for gold. Especially if we take into account the lower economic growth which – I reckon – will be rather lower than higher this year compared to in 2018.