Wealth Strategies
The Bull Case For Yellow Miners
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Gold prices have surged this year, which clearly suggests that the mining companies that extract and process gold will benefit. The manager of an investment portfolio examines the opportunities.
The following article, which focuses on the gold mining
sector and the reasons for being positive on it, comes from Tom
Roderick, portfolio manager at Trium Capital, a
UK/Ireland-based liquid alternatives asset manager. Roderick is
manager of the Trium Epynt Macro Fund.
The editors of this news service are pleased to share this
content; the usual editorial disclaimers apply to views of guest
contributors. Email tom.burroughes@wealthbriefing.com
and amanda.cheesley@clearviewpublishing.com
if you wish to respond.
In recent years, Western investors have been replaced by emerging
market central banks as the key drivers of the price of gold,
changing the relationship between gold and interest rates. Much
of the buying by central banks is secretive. While the increase
in officially declared purchases has been relatively modest,
there are fingerprints to suggest that emerging market (EM)
central banks have been mopping up supply in other channels.
Chinese buying outside of the central bank has stepped up
significantly as other state institutions have tapped the
market.
Mine of opportunity
Our current positioning is via gold miners rather than physical
gold. We think investor concerns about the miners are misplaced
when making a proper comparison taking all relevant factors into
account. There are two major reasons why long-term historical
analysis comparing physical gold to miners is often flawed.
Firstly, there is a lack of accounting for dividend accrual on
the miner side. When you compare one equity market
with another, or two individual stocks, it does not matter
hugely if both have similar dividend payouts. When comparing gold
to gold miners, however, you are comparing a zero-pay-out asset
to one with high cashflows, which becomes increasingly important
as you extend the period of analysis.
Secondly, gold miners have a significantly different volatility
profile to that of the metal. The risk and potential return
associated with gold equities is about 2.5 times that of gold.
When interest rates are low, the opportunity cost of bigger
position sizes is also low.
When rates are higher, taking a much larger position in physical
gold (e.g. 25 per cent NAV) rather than a smaller, but
risk-equivalent, position in gold miners (e.g. 10 per cent NAV)
sacrifices an extra 15 per cent of portfolio assets that can’t
sit in high-yielding bills. Over the long term this adds up. When
you correct, taking in account these factors and carry
out a long-term analysis, the perceived structural outperformance
of gold over the miners disappears.
Relative analysis
We have run our analysis from 1980 onwards using Newmont; the
largest listed miner and the gold stock with the longest single
history. Our analysis compares the performance of a 10 per cent
NAV position in the miner with a risk-equivalent investment of 25
per cent NAV in the metal. Before accounting for interest rate
sacrifice, the miner and the metal have delivered similar returns
of 62 per cent and 58 per cent, respectively, since
1980.
Due to the much larger notional size in gold relative to the
miner, the interest rate sacrificed in holding the metal is
significant, all but eliminating positive returns accrued over
the period (realised return of just 1 per cent since 1980). The
return on the miner is also meaningfully reduced to 38 per cent
but is far less impacted than the metal, hence running an RV
trade long the metal relative to the miner would have resulted in
a 28 per cent loss over the period.
Contrary to popular belief, it has not been a bad strategy to
play the miners instead of the metal. Gold persistently
underperformed miners during the gold bear market from 1980 to
2001; and after factoring in the high rates prevalent during the
period, performance was substantially worse still.
Bull market blues
It seems that much of the investor frustration stems from the
2003 to 2013 bull market when gold genuinely outperformed the
miners, even after all factors were accounted for. Again, actual
outperformance was less than commonly thought, but it is still
clear outperformance.
We believe that this historical aberration can be explained by
ill capital discipline over the period coupled with a very high
starting valuation. 2003 also saw the approval of the first gold
ETF, absorbing sizeable flows that might have otherwise been
destined for equity plays.
Gold miners have learnt their lessons and are much better
custodians of capital today, while Newmont’s current P/E is an
unchallenging 15x (less than half of what it was at the start of
the 2003 to 2013 bull market).
Investors have been scarred by the 2003 to 2013 outperformance of
gold. What at first looks like a continuation of that
outperformance since then has been completely eroded by interest
rates. While historical analysis doesn’t tell you how to play the
theme today, we believe that correcting the record is
important.
Stronger support
The structural underpinning of the gold market is stronger now
that it has found a significant, more resilient, new buyer in
non-US-aligned central banks. No longer is gold purely at the
whim of US real rates. We still think that if real rates go down,
then gold will go up, but buying will get more crowded and the
price will go up even quicker.
Central bank buying is less cyclical and offers more long-term
certainty of price-insensitive gold demand. So long as the
US/China relationship remains strained and China maintains its
policy of industrial surplus, then the buyer will be there. This
reduces the volatility of the outlook for gold and, hence, should
make gold reserves in the ground more valuable, leading to a
re-rating of the currently undemanding valuation levels.
Our main point remains that investors should own more gold,
whether or not they do that via the miners. We see it as a
long-term opportunity, but not necessarily a 40-year “buy and
hold.” While the miners are currently our preferred way of
playing the theme, as macro investors we remain willing to trade
around shorter-term market gyrations.