Inflation or Deflation - Buy Gold
Also Seasonality Review and Quarterly Preview
We Maintain Our Positive View on the Gold Market – The primary focus of
this report is to review the possible impact that a deflationary environment
would have on the price of gold. With the caveat that comparisons to past
deflationary periods are challenging, we argue that prolonged deflation would
be positive for gold. In a deflationary environment, we expect capital to shift
to “safe haven” currencies to preserve value. Given the declining credit
worthiness faced by major global currencies (particularly the US$) following
record debt expansion, and also considering their balance sheets would be
placed under further pressure if deflation persisted, we expect gold by default
(given its relative credit worthiness) would ultimately be the preferred place to
hide.
If prolonged deflation is avoided (which is our view), we believe that the
significant increase in money supply in conjunction with exorbitant stimulus
packages would lead to rampant inflation, with the Fed unable and perhaps
unwilling to increase interest rates (its exit strategy) given it would not want to
risk derailing the recovery. Inflation would thus erode the value of the US$
and in turn would make gold a much more attractive investment.
In this report we also address some of the current news items that are causing
“noise” in the gold market including the announcement by India to double its
import tax on bullion and the potential sale of gold by the IMF. We would also
highlight that we are in a period of traditionally low investment interest in
precious metals. This seasonality has historically provided excellent buying
opportunities early in 3Q – (demonstrated in 7 of the past 8 years).
At current levels, we recommend investors buy Yamana, Eldorado, Lake
Shore Gold and Pan American Silver given their discounted valuations,
strong growth profiles and low operating costs. Of the developers, we
recommend Detour given its size, location and valuation.
Quarterly Preview – Over the next few weeks gold and silver companies will
be reporting quarterly results. We expect i) modest earnings growth QoQ,
particularly with companies exposed to base metals, ii) improved margins
QoQ, and iii) potential downward cost guidance revisions.
Precious Metal Price Update – We are maintaining our 2009 and 2010 gold
price assumptions of $1,000/oz and $1,050/oz, respectively, however we are
increasing our silver price assumption modestly for 2009 from $13.20/oz to
$13.40/oz and maintaining our 2010 estimate of $13.75/oz.