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The Sochi 2014 Winter Olympics weren’t the only place where Canada has made a good showing with an emphasis on gold. The S&P/TSX Composite Stock Index has gained 4.6% thus far this year at the time of writing, one of the better returns among the major industrialized markets. Moreover, like the Olympics, gold has been driving the gains, with the TSX Gold sub-index gaining over 30% so far this year, a sharp reversal from its woeful performance in 2013. While gold bullion is also rising, its year-to-date gain of slightly over 10% pales in comparison to the performance of the gold stocks. Clearly some of this is just a recovery from the extremely low valuations reached last year as investors liquidated their holdings in the gold ETF. But the gold companies have also shown a greater focus on cost reduction and cash management than growth in production. Gold prices also found support at the critical US$1180 level, which was the breakeven point for many of the higher cost producers.
The other trend that we pointed out a few months ago was that, while financial market players were liquidating their holdings in the gold ETF at a huge rate in 2013, there were some large foreign buyers of physical gold for jewelry and investment purposes. The financial selling, however, overwhelmed the physical buyers and gold prices fell. As the financial selling slowed down in the past two months, the physical buyers have remained in the market. That has lead to a recovery in the price of gold. The chart below shows Net Gold Imports into Hong Kong. China has been a substantial buyer of physical gold and that shows up well in this import data.
While we don’t expect gold to rush back to its old high anytime soon, the stocks are clearly acting well and investors are getting more comfortable with the strategies being deployed management groups. Barrick Gold has shut down unprofitable mines and did a major equity raise to reduce their financial risk. B2Gold, Semafo and Sulliden have good growth profiles among the mid-sized companies. We also added the GDXJ (Market Vectors Junior Gold Miners ETF) to our portfolios, as it has good diversification among a strong group of junior miners. GDXJ has gained over 35% so far this year.
During the last week of February we got the earnings reports for the major Canadian banks. The commentaries by the CEO’s of many of Canada’s largest banks during their reporting period have raised some flags, in our view, about the outlook for economic growth in Canada. While the earnings reports in general have been good, with all the majors beating the estimates for the quarter on stronger capital markets revenues, improvements in retail banking and continued growth in wealth management, the bank CEO’s all seem to be concerned about the overall level of consumer debt in Canada and how this could become an ‘anchor’ on future economic growth. The debt to income ratio has recently risen to over 160%, a record level. They expect that these high debt levels are a concern and seem to point to the housing market as their area of greatest risk. Some of this commentary may have been the reason that the bank stocks had a mostly muted response to the strong earnings reports. We continue to like CIBC for its improved retail growth, TD Bank for its exceptional growth in the U.S. and National Bank for its valuation discount to the rest of the banking group. Our best small stock pick in the financial sector continues to be Element Financial, an emerging leader in the industrial leasing market. The company is well-capitalized, has a seasoned management team and has booked strong growth in its four core areas of growth.
Back on the outlook in Canada, the economic comments by the bank CEO’s dovetail very well with the warning from one of the world’s biggest and most respected hedge funds, which predicts that Canada’s economy has a tough decade ahead of it. Bridgewater Associates says the country’s economy is just beginning a tough period of rebalancing. It’s a fairly common belief that this country, after a long boom, is likely to go through a retrenchment as consumers cut spending to pay debt, and that there are also risks posed by the long surge in housing prices. Bridgewater, based in Connecticut, manages about $US150-billion and specializes in macro strategies – calling major trends such as countries’ ups and downs. The firm has made more money for clients than any firm in the history of hedge funds, according to Institutional Investor’s Alpha publication.