The Outlook for Gold and Gold Stocks. 2 Rochelle Toplensky, Michael Hunter and Eric Platt (2016,

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1 1 September 1, 2016 INVESTMENT STRATEGY NOTES Nick Majendie, CA Director, Wealth Management ScotiaWealth Senior Portfolio Manager, with responsibility for advising the Anchor The Outlook for Gold and Gold Stocks Stock market outlook In our August 16 Anchor Note, we made the following comments: if oil, base metal and gold and silver prices continue to improve, the midsingle digit overall returns for the next 12 months that we have been forecasting for the (Toronto Stock Exchange) TSX could easily turn out to be too conservative. For example, our Dividend Growth portfolio has an approximate 14% weighting in precious metals stocks. Our positioning has been based on an estimate of a $1,300 per ounce gold price and a $20 silver price over the next 12 months (recently increased to $22). However, we believe there is a strong case for precious metal prices going substantially higher than these levels in a world of negative interest rates and geopolitical uncertainty, in which case our stock price targets in this sector could prove to be considerably understated. 1 Since we have interviewed all the major gold companies listed on the TSX with the exception of Barrick Gold Corp. (ABX) over the last couple of months (we are planning to visit with ABX management in Toronto later this month), we thought it would be timely to highlight the gold sector in this Anchor Note. Outlook for gold and gold stocks Introduction Gold bullion and gold stocks have suffered a modest pullback over the last few weeks. We believe the major reason has been profit taking and the fears of more hawkish comments by Janet 1 Nick Majendie (2016, Aug 16). Anchor Notes. Yellen at Jackson Hole on Aug 26, Nevertheless, gold bullion as of last week was still up 24% year-to-date while the XAU (Philadelphia Gold/Silver Index) has more than doubled so far this year (+114%). 3 What is this attributable to? a) Strong investment demand The August Gold Council Quarterly report, reviewing the second quarter and first half supply/demand picture highlighted the strong demand for physical gold. Total demand in the first half was the second highest ever (the record was in the first half of 2009). 4 The major factor was investment demand, which was a record and was 16% higher than the previous high in the first half of Investment demand, according to the World Gold Council, was driven by a very large increase in Exchange-traded fund (ETF) inflows (+579 tonnes). 4 With the sharp increase in the price of bullion, demand in the form of jewellery was relatively soft. Total supply increased 10% in the second quarter compared to Q However, the World Gold 2 Rochelle Toplensky, Michael Hunter and Eric Platt (2016, Aug 26). Janet Yellen s Jackson Hole speech: the view from markets. US Equities. Retrieved from 3 Thomson Reuter (2016, Aug 26). 4 World Gold Council. (2016, Aug 26). Gold Demand Trends, Second Quarter Retrieved from

2 2 Council points out that first half supply only increased 1%, marking the smallest increase in eight years. Mine production in Q2 was essentially flat (down three tonnes year-over-year) as recycling of gold caused by the higher price (+23%) was responsible for all of the increase in supply. 4 b) Managed Money positioning in gold As mentioned above, investment demand through ETF s has been running at record levels this year. Gold bullion tends to do well in times of uncertainty and investors have been faced with a considerable amount of that at various times this year. In January/February, there was widespread concern about a North American/global recession which has now largely dissipated but the Brexit scare certainly provided a further boost to demand for gold although again the fears of the possible consequences have since been alleviated by central bank action. The European Central Bank (ECB), the Bank of England and the Bank of Japan have all announced various forms of incremental quantitative easing. One of the key consequences of central bank action has been an increasing quantity of bonds globally selling at negative interest rates now estimated to be US$13 trillion out of a global figure of about $80 trillion. In terms of sovereign bonds, the quantity of bonds trading at negative interest rates is much more significant. The World Gold Council (WGC) estimates that US$10 trillion of high quality sovereign debt is trading at a negative rate out of a total of US$25 trillion. 5 In addition, the WGC calculates that a further $9 trillion sits on central bank balance sheets as a result of their asset 5 World Gold Council (2016, Aug 3). Market Update, Failed monetary policies lift gold. Retrieved from purchase programmes creating a shortage of quality sovereign bonds. This explains the global reach for yield whether in lower quality corporate bonds and emerging market bonds as well as resulting in increased demand for dividend yielding equities which inherently have a longer duration than bonds. Historically, the lack of a positive carry has been cited as a negative for gold. However, in a world of significant quantities of bonds selling at a negative interest rate, this is much less of a constraint to gold ownership. We agree with the WGC s comment that investors are using gold to hedge portfolio risk as they add more stocks and low quality bonds to their asset mix. 5 Finally, there is growing commentary about the inefficacy of monetary policy globally. Unprecedented measures to reduce interest rates have not improved gross domestic product (GDP) growth since the Financial Crisis although these measures certainly have helped financial assets. Gold, in our opinion, is increasingly seen in its traditional role as a safe haven and an alternative to cash. Although investment demand through ETF s has increased significantly, ETF holdings are still 25% below their 2012 peak, according to the WGC. 4 Our suspicion is that the increase in investment demand for gold bullion is in its early stages and in no way is showing the type of public participation that was evident in the later part of the 1970 s through to the 1980 peak. We believe that there is a real possibility that in these circumstances, gold could well challenge its 2011 high of $1925 in this cycle. If this were the case, silver would likely challenge its all-time 1980 high of $50 per ounce as, in bull markets, it always tends to outperform gold. c) Seasonality In terms of seasonality, we have mentioned in previous Notes that May/June tends to be a seasonal low point for gold and gold stocks. Performance of both is often robust between July

3 3 and October. Thus, although gold bullion has pulled back moderately, it could well recover over the next couple of months. This of course does not speak to the long term. d) The message from recent interviews with precious metal companies. Our recent interviews with the companies underlined the continuing emphasis on the part of all the managements of the major gold miners to stress profitability rather than production growth as a result of investor pressure to improve returns. For the last three years, companies have been providing guidance around all-in costs per ounce (AISC) not just operating cash costs but also general & administrative, debt service, exploration and sustaining Capex costs. On this basis, for example, Barrick s all-in cash costs were estimated three years ago at $1000 an ounce, Goldcorp at $1,050 an ounce, Agnico Eagle Mines Ltd. at $1,100 an ounce while Yamana was targeting $900 an ounce by the end of Kinross Gold Corp s Q all-in costs were $1,038 per ounce. Actual AISC for Q2 this year was $782 per ounce for ABX (the decline over the last three years has been the result of ABX shedding high cost operations), $848 for AEM, $1,067 for G (atypically high due to a production shortfall), $988 for K and $949 for YRI. According to our interviews with these companies, the balance sheets for the various companies vary considerably. However, principally Barrick, but also Kinross and Yamana, have seen their balance sheets improve significantly over the last few years. Three years ago, ABX had in excess of $12 billion of debt and we believe that could be reduced to $5 billion or below by the end of next year. Goldcorp is in excellent shape financially as it had debt at the end of Q2 of $2.8 billion with cash of $328 million. Agnico Eagle had long term debt of $1.2 billion at June but cash of $468 million and lines of credit of $1.2 billion million. As at mid-year, Kinross had debt of $2.0 billion but cash of $968 million and lines of credit of $1.5 billion. Yamana has the weakest balance sheet of those we cover with $1.7 billion of debt with cash of $93 million, which will increase by $123 million after the sale of its Mercedes mine in Mexico is complete. Franco Nevada Corp. has no debt and cash of $349 million and a line of credit of $1.0 billion. Silver Wheaton Corp. has no long term debt but uses its bank lines to fund its acquisitions. At June 30, 2016, the Company had approximately $124 million of cash on hand and $706 million outstanding under the Company's $2 billion revolving term loan. e) Valuations of the various companies We have always preferred to evaluate gold companies on the basis of cash flow. Obviously, cash flow per share (CFPS) estimates going out this year and the next couple of years are highly dependent on the gold price assumption one uses. We are using $1,260 per ounce as an average for this year and $1,300 an ounce for next year through to For the next three years, we are using $22 per ounce for silver. On this basis, ABX has the weakest forecast growth in CFPS between 2016 and 2019 being roughly flat. The strongest growth in CFPS over this period would be experienced by Yamana at 66% - followed closely by Agnico Eagle at 56%. Our forecast for 2019 CFPS for Kinross and Goldcorp is for an increase of 34% and 27% respectively over 2016 estimated levels. Cash flow projections for both Franco Nevada and Silver Wheaton going out three years are of necessity conservative since they do not include any future mergers and acquisitions activity for either of these streaming companies. The following table sets out our one year stock price targets for the seven precious metals stocks in our universe and the estimated three year annual total shareholder return we have for each stock.

4 4 Table 1. Calculations of gold stocks. (All data used are collected from Bloomberg, and all calculations are by Nick Majendie) Stock Name Price as of 2016 CFPS 2019 CFPS 1 Year Target* 3-year TSR 8/26/2016 (estimate)* (estimate)* (estimate) Barrick Gold $23.65 $3.35 $3.32 $32 1% Agnico Eagle $68.08 $3.62 $5.64 $76 10% Franco Nevada $93.88 $3.37 $3.08 $105-3% Goldcorp $20.75 $2.14 $2.71 $34 25% Kinross $5.58 $1.08 $1.45 $9 22% Silver Wheaton $34.46 $2.02 $2.28 $61 11% Yamana $5.74 $0.87 $1.44 $9 *Canadian dollars converted at % As previously stated, the total shareholder return targets for Franco Nevada and Silver Wheaton are likely to be understated because the 2019 CFPS estimates do not account for any future mergers and acquisitions activity. In addition, in the case of Silver Wheaton, a favourable resolution of its dispute with CRA which is going before the courts and likely to be resolved in the next months would add significantly to the three year stock price target. We estimate that the shares are being penalized by about $3 billion in terms of market capitalization by the CRA overhang. Portfolio changes The significant trades in the Anchor Funds in the last two weeks were the purchase of an initial position in Potash Corp (POT) and Methanex Corp (MX). We have not invested in Potash since launch of the Anchor funds and the funds have not invested in Methanex since However, we are optimistic that both the price of potash and the price of methanol are in the process of bottoming. Methanol pricing tends to follow the direction of oil prices. We are optimistic on reasonable further oil price recovery before year end as the supply/demand gap narrows. A modest improvement in potash pricing is forecast over the next few quarters and POT s dividend looks to be safe after the second cut. Purchases of both were made in the Anchor Dividend Growth and High Income funds. These purchases were funded out of our cash positions and profit taking in Arc Resources and Brookfield Property Partners in the Anchor Dividend Growth fund. In the Anchor High Income fund, in addition to the above mentioned purchases of Methanex and Potash, we added modestly to our holdings of Enbridge Inc. and Bank of Nova Scotia. Nick Majendie, CA Director, Wealth Management, Senior Portfolio Manager, ScotiaWealth PLEASE NOTE: IMPORTANT DISCLOSURES AND DISCLAIMERS ARE CONTAINED ON THE FOLLOWING PAGES.

5 5 I The Bank of Nova Scotia am the parent company of Scotia Capital Inc. ( SCI ) and am therefore a related issuer of SCI. Scotia Managed Companies Administration Inc., a wholly-owned subsidiary of SCI, is the manager of the Anchor. ScotiaWealth, a division of SCI is the portfolio advisor to the Anchor. Nicholas L. Majendie, who is employed by ScotiaWealth, provides portfolio advice to the Funds. This information reflects Mr. Majendie s opinions as of the date of these notes. These opinions may change at any time and neither Mr. Majendie, ScotiaWealth nor their affiliates undertake to update the information or opinions. This information and opinion does not constitute investment advice or an offer to trade securities. Anchor hold securities of the following issuers referred to in this note: Arc Resources Ltd, Bank of Nova Scotia, Barrick Gold Corp, Enbridge Inc., Goldcorp Inc., Kinross Gold Corp., Methanex Corp., Potash Corp., Silver Wheaton Corp. and Yamana Gold Inc. Nick Majendie, who provides portfolio management advice to the Anchor, personally holds securities of the following issuers referred to in this note: Arc Resources Ltd, Bank of Nova Scotia, Barrick Gold Corp, Enbridge Inc., Goldcorp Inc., Kinross Gold Corp., Methanex Corp., Potash Corp., Silver Wheaton Corp. and Yamana Gold Inc. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. These Anchor are distributed under a Simplified Prospectus. The Simplified Prospectus, Fund Facts and Annual Information Form are available from ScotiaWealth or on This publication is intended only to convey information. It is not to be construed as an investment guide or as an offer or solicitation of an offer to buy or sell any of the securities mentioned in it. The author is an employee of ScotiaWealth, a division SCI, but the data selection, analysis and views expressed herein are solely those of the author and not those of SCI. The author has taken all usual and reasonable precautions to determine that the information contained in this publication has been obtained from sources believed to be reliable and that the procedures used to summarize and analyze such information are based on approved practices and principles in the investment industry. However, the market forces underlying investment value are subject to sudden and dramatic changes and data availability varies from one moment to the next. Consequently, neither the author nor SCI can make any warranty as to the accuracy or completeness of information, analysis or views contained in this publication or their usefulness or suitability in any particular circumstance. You should not undertake any investment or portfolio assessment or other transaction on the basis of this publication, but should first consult your investment advisor, who can assess all relevant particulars of any proposed investment or transaction. SCI and the author accept no liability of whatsoever kind for any damages or losses incurred by you as a result of reliance upon or use of this publication in contravention of this notice.

6 6 The statements in this newsletter may contain statements related to future financial performance of certain securities, indices or the Anchor Managed funds that may constitute forward-looking statements. These statements may be identified by words such as expect, look forward to, anticipate, believe, seek, estimate, project, potential, predict, or words of similar meaning. Such statements are based on the current expectations and certain assumptions of the author, and are, therefore, subject to certain risks and uncertainties. A variety of factors, many of which are beyond the author s control, affect the performance of the securities and capital markets indices and therefore the performance of the Anchor funds and could cause the actual results, performance or achievements of the securities, indices or the Anchor funds to be materially different.