OCM Market Commentary
From the 2022 Annual Report. To view the complete Annual Report, click here.
The Russian invasion of Ukraine was the most significant event over the past year, in our opinion. It was an inflection point not only for the geopolitical landscape but also global monetary order – the end of dollar hegemony. Issues that have been festering just under the surface breached for all to see. After years of extraordinary monetary policies to counter the Covid Pandemic and prior liquidity crises, the war provided the catalyst to unleash inflation. The Federal Reserve’s (the “Fed”)1 aggressive interest rate response after initially believing inflation was ‘transitory” pulled the plug on the bull market in both equities and bonds. Removing the opportunity cost associated with bull markets in financial assets, gold prices posted positive returns in almost every currency globally in 2022.
The tectonic shift in the geopolitical landscape was summarized by Credit Suisse strategist, Zoltan Pozsar,
“Since the end of WWII, the only Great Power conflict investors really had to deal with was the Cold War, and since the conclusion of the Cold War, the world enjoyed a unipolar “moment” – the U.S. was the undisputed hegemon, globalization was the economic order, and the U.S. dollar was the currency of choice. But today, geopolitics has reared its ugly head again: for the first time since WWII, there is a formidable challenger to the existing world order, and for the first time in its young history, the U.S. is facing off against an economically equal or, by some measures, superior adversary.”
China and Russia are leading a group of commodities-producing and manufacturing countries looking to de-dollarize and forge a new monetary order not aligned with U.S. interests. Writing in the People’s Daily back in 2008, Chinese economist Shi Jianxun lamented: “The world urgently needs to create a diversified currency and financial system and fair and just financial order that is not dependent on the United States.”
The freezing of Russia’s foreign exchange reserves appears to have hastened the move to de-dollarize. Saudi Arabia has agreed to abandon the petrodollar and accept other currencies for oil settlement. The petrodollar allowed the U.S. a privileged position to run deficits at a favorable exchange and interest rates since the early 70’s that the rest of the world didn’t enjoy. Central bank’s buying of gold in 2022 reached its highest level since 1968, the year the London Gold Pool protecting the gold price at $35 had to be abandoned. Non-U.S. aligned foreign central banks see a future where they no longer need to hold the same level of dollar assets for trade and are selling U.S. Treasury securities and beefing up holdings of gold as a neutral reserve asset.
Moreover, Secretary Jack Lew warned about dollar sanction overreach in 2016 as pointed out by Zoltan Pozsar, “the more we condition the use of the dollar and our financial system on adherence to U.S. foreign policy, the more the risk of migration to other currencies and other financial systems grows”. With $32 trillion in debt and rising interest expense compounding the issue, the need to finance U.S. government debt is growing at a pace the rest of the world may be unwilling to absorb near current interest rates, considering the weaponization of the dollar and the move to a multi-polar world, in our opinion. The Fed may find itself needing to practice extensive yield curve control operations through balance sheet expansion to finance the U.S. government at interest rates low enough to avoid economic contraction if foreign buyers are no longer there. Should inflation remain elevated above the Fed’s 2% target rate, monetizing U.S. debt on the Fed’s balance sheet may lead to a steep markdown of the U.S. dollar versus gold, in our opinion.
The prospect for a period of stagflation over the next 12-18 months is more likely than a “soft landing”, in our view. The yield curve inversion of short-term rates higher than longer-term rates has historically forecast an economic contraction. The yield curve in 2022 was the most inverted it has been since September 1981. If history is a guide, the bond market is pointing to a recession over the next year. The prospect for inflation to remain elevated is related to several factors, in our opinion, namely: labor pressing for cost-of-living increases; de-dollarization increasing the cost of commodities in dollars; manufacturing moving away from low-cost labor centers; and wars arInflate inflationary. In the stagflation period of the 1970’s, gold assets proved to be the best-performing asset class.
Shares of Gold Mining Companies
In review, shares of gold mining companies experienced a challenging year as inflation and lingering supply chain issues led to uneven performance across the sector. The industry suffered from three consecutive quarters of increased average all-in-sustaining costs mostly from inflated fuel and cyanide costs. While these increases impacted sentiment toward the precious metals sector in the short-term, costs have since subsided and are estimated to fall further over the next two years. We foresee inflationary pressures trailing gold price increases in the intermediate term, leading to the gold mining sector seeing the benefits of added cash flow at a time when other sectors are experiencing declining earnings.
Historically, shares of Junior Gold Producers, such as Jaguar Mining, Inc. and Wesdome Gold Mines Ltd. have provided strong relative performance for the Fund. In the cases of Jaguar and Wesdome, both remain poised to deliver production growth over the next two years despite challenges that set production timetables back by twelve months. The Fund has historically had a low turnover signifying our long view of letting our investment thesis on individual companies play out.
Precious metals exploration over the past decade has not kept pace with ore body depletion from mining, punctuating the scarcity value of gold. The bulk of what has been discovered is extremely low grade with unattractive rates of return on capital or in unfavorable operating jurisdictions. Combined with the long lead time from discovery to production of seven to twenty years due to the development and regulatory hurdles to bring a new mine onstream, the trend is for shrinking or flat production by the major gold producers going forward with an emphasis on higher-margin ounces rather than gross production numbers. With major gold producers seeing flat production over the next three to five years along with challenges discovering new ounces, a period of mergers and acquisitions in the precious metals sector seems likely, in our opinion.
Your Fund’s investment strategy remains a disciplined approach to searching out value and growth opportunities across all segments of the precious metals industry on a global basis. We believe companies that possess strong management, large reserves in the ground in stable jurisdictions and exhibit capital discipline while holding equity dear, will be the companies that outperform over time as they deliver higher levels of free cash flow to maintain a sustainable business model to create shareholder value. We are specifically targeting companies with existing production that possesses large reserve expansion potential where shareholder value can be created through the drill bit. Your Fund has the flexibility to maneuver within the precious metals sector to invest in opportunities that larger funds and exchange-traded funds cannot; from major gold producers with over one million ounces of annual production, to junior producers with less than 100,000 ounces of annual production, to small exploration and development companies with micro capitalizations.
Wars are historically inflationary. The Russian invasion of Ukraine and the U.S. participation by proxy has proven to be no exception. The origins of the current inflation can be traced back to the Fed’s extraordinary monetary policies enacted to counter liquidity crises in the banking system, such as the 9/11 – dot-com bubble bust, the 2008 Global Financial Crisis and the Covid Pandemic. The Russian-Ukraine war also hastened the move from a unipolar world to a multipolar world that is looking to de-dollarize. A tectonic geopolitical shift, in our opinion, has taken place with profound implications for the USD and demand for Treasury securities going forward. The accelerated buying of gold and selling of U.S. Treasury securities by foreign central banks is no doubt part of the move to de-dollarize, in our opinion. Further, we believe investors should take note that inflation has broken the back of the financial asset bull market in both equities and bonds. The ratio of the S&P 500 to gold rising is a signal a major investment cycle change is in progress from financial assets to real assets, in our opinion. Shares of precious metals mining companies from the 2001 to 2011 period of rising S&P 500 ratio to gold delivered a strong relative performance to the S&P 500.
Relying on gold’s 5,000-year monetary history, we expect gold to continue to retain its purchasing power as the USD is faced with further debasement to meet its growing U.S. debt obligations. Horizon Kinetics notes the familiar pattern of the USD:
“Over the past 73 years, the USD also lost over 91% purchasing power through persistent debasement. Currency devaluation is hardly a new phenomenon. During the 73 years between Marcus Aurelius’s reign ending in 180 CE and the beginning of the reign of Emperor Gallienus, the denarius silver coin was periodically debased – by mixing in a cheaper base metal, like lead – from 75% silver to only 5%.”
We appreciate your shareholding and confidence in the OCM Gold Fund, and we look forward to meeting the investment objective of preserving your purchasing power. Should you have any questions regarding the Fund or gold, please contact your financial adviser or you may contact us directly at 1-800-779-4681. For questions regarding your account, please contact Shareholder Service at 1-800-628-9403.
Gregory M. Orrell
January 23, 2023
Federal Reserve1 is the central bank of the United States and arguably the most powerful financial institution in the world. The Federal Reserve System was founded by the U.S. Congress in 1913 to provide the nation with a safe, flexible, and stable monetary and financial system.