Jean-Marie Eveillard's First Eagle U.S. Value Fund Third Quarter Commentary
In the third quarter of 2012, the S&P 500 Index increased 6.4%. Crude oil jumped 6.9% to $92.19 a barrel, and the price of gold fluctuated—dropping 1.9%, then rising 13.1% to rest at $1,773 an ounce by quarter-end. The U.S. dollar fell 2.3% against the yen and it dropped 1.5% against the euro.
As the third quarter came to a close, there was much speculation regarding the impact that a third round of quantitative easing— "QE3"—could have on financial markets. As a result, in this quarter's commentary we'd like to focus on QE3 and its potential impacts.
The Federal Reserve's (Fed) actions were based on familiar facts: Economic activity for U.S. business was slower than expected; the Fed felt the inflationary outlook over the medium term would likely run below its 2% target; and unemployment levels remained elevated.1
What followed were three fairly unprecedented actions by the Fed. First, the Fed made a commitment to keep short-term interest rates between zero and a quarter of a percent until mid-2015. Given that interest rate targets were initially lowered to this range in the end of 2008, mid-2015 translates into an approximately seven-year period when investors will not have been able to earn a real return on capital in "risk-free" investments.
The Fed then went a step further: It committed to buying approximately $1 trillion worth of long-term securities. This will take the form of the outright purchase of approximately $40 billion a month of mortgage-backed securities, and another approximately $45 billion a month of maturity extensions as they roll their existing holdings.
Next, the Fed made its commitment open-ended. In its press release, the Fed specified that "if the outlook for the labor market does not improve substantially," it would "undertake additional asset purchases and employ its other policy tools as appropriate until such improvement is achieved in the context of price stability."
So, will QE3 stimulus result in a better economy? We believe that it might feel better in the short term, but may have negative side effects in the long term.
Unfortunately, printing money is not a miracle cure. We do not believe that this form of monetary easing is going to create a structurally better economy. Historically, these types of actions have simply transferred wealth from prudent long term savers to long term borrowers. The Fed has materially expanded the monetary base under the banner of its dual mandate of reducing unemployment and controlling inflation but what real good does printing money do?
While these moves could create a cyclical rebound in consumption and behavior, this rebound also could bring a worsening of the savings and investment imbalance in the U.S. as it creates more upward pressure on prices of things made in the U.S. and is aimed at trying to reduce savings. This could lead to more difficult policy decisions in the future. The cumulative effect of the "easy money" policies already administered over the last decade has been that the savings imbalance has morphed into a large fiscal imbalance. Resolving this will require a degree of policy nuance and compromise that has not been present to date.
The picture is not entirely bleak. We still believe that it is possible to selectively identify companies that participate in the growing pool of human potential. Economic history shows that despite being frequently interrupted by economic and political crises, a human tendency towards productive commerce is arguably likely to be the long-term inevitability.
We are in the business of owning primarily long-duration risk assets, be they equities or gold. That makes calculating the impact of the Fed's latest round of quantitative easing difficult. It's clear that if you own an investment-grade bond that's going to mature in three years, it should be priced off the Treasury curve. If you own a perpetual asset, though, the value of your holdings is not just the sum of the cash flow for the next five years; it is contingent on the health of the financial architecture in the years following.
As a result, in the third quarter, we have managed our funds with what could be described as aggressive reflection and selective action. We believe that equities are within a rational range; this means that the businesses we would like to own are harder to find at what we believe are bargain prices. Given the economic turbulence around the globe, we are not going to take what we consider to be unnecessary risk in order to deploy more capital. The fact that we have maintained our underwriting discipline means that as a residual effect, our cash and cash equivalent levels (including commercial paper) have crept up to around 20%.
We believe that holding cash and cash equivalents is prudent and gives us the flexibility to both endure and take advantage of any windows of crises that could result from political challenges during the long term process of adjusting global imbalances.
The top five contributors to the U.S. Value Fund during the quarter were Gold Bullion (+0.44%), Nexen Inc. (NXY) (+0.39%), Newcrest Mining Ltd. (NCMGF) (+0.32%), Agnico-Eagle Mines Ltd. (AEM) (+0.32%) and Cisco Systems Inc. (CSCO) (+0.30%). The top five detractors were Intel Corporation (INTC) (-0.22%), FirstEnergy Corporation (FE) (-0.20%), Lorillard Inc. (LO) (-0.12%), WellPoint Inc. (WLP) (-0.12%) and Microsoft Corporation (MSFT) (-0.06%).
We continue to own gold as a potential hedge against extreme outcomes. Gold is a perpetual asset; it will likely last forever. Because of this, the price of gold embodies expectations about the future. As of this writing, the elevated gold price already contains an element of expectation of how weak the sovereign financial architecture is. At the margin we have added to gold mining stocks over the bullion given they embody less expectation.
In a world where the monetary base is increasing in its abundance, we are steadfast in our commitment to investing in scarcity—scarcity need not only be embodied in our potential hedge and gold related investments but also companies that control hard to replicate market positions or reserves of supply constrained commodities and real assets. When we cannot find such scarcity in the business model or assets, we need the scarcity to be in the price with an unusually wide margin of safety.
We appreciate your confidence and thank you for your support.
The performance data quoted herein represents past performance and does not guarantee future results. Market volatility can dramatically impact the fund's short-term performance. Current performance may be lower or higher than figures shown. The investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Past performance data through the most recent month end is available at firsteaglefunds.com or by calling 800.334.2143. The average annual returns for Class A Shares "with sales charge" of First Eagle U.S. Value Fund give effect to the deduction of the maximum sales charge of 5.00%.
*The annual expense ratio is based on expenses incurred by the fund, as stated in the most recent prospectus.
Investment in gold and gold related investments present certain risks, and returns on gold related investments have traditionally been more volatile than investments in broader equity or debt markets.
The principal risk of investing in value stocks is that the price of the security may not approach its anticipated value or may decline in value. All investments involve the risk of loss.
The holdings mentioned herein represent the following percentage of the total net assets of the First Eagle U.S. Value Fund as of September 30, 2012: Gold Bullion 4.28%, Nexen Inc. 0.60%, Newcrest Mining Ltd. 1.31%, Agnico-Eagle Mines Ltd. 1.35%, Cisco Systems Inc. 2.78%, Intel Corp. 1.28%, FirstEnergy Corp 1.75%, Lorillard Inc. 0.90%, WellPoint Inc. 1.40%, Microsoft Corp 2.55%. The portfolio is actively managed and holdings can change at any time. Current and future portfolio holdings are subject to risk.
The commentary represents the opinion of the Global Value Team Portfolio Managers as of September 30, 2012 and is subject to change based on market and other conditions. The opinions expressed are not necessarily those of the entire firm. These materials are provided for informational purpose only. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Any statistics contained herein have been obtained from sources believed to be reliable, but the accuracy of this information cannot be guaranteed. The views expressed herein may change at any time subsequent to the date of issue hereof. The information provided is not to be construed as a recommendation or an offer to buy or sell or the solicitation of an offer to buy or sell any fund or security. Standard & Poor's 500 Index is a widely recognized unmanaged index including a representative sample of 500 leading companies in leading sectors of the U.S. economy and is not available for purchase. Although the Standard & Poor's 500 Index focuses on the large-cap segment of the market, with approximately 75% coverage of U.S. equities, it is also considered a proxy for the total market.
The Index is unmanaged, and the results include reinvested dividends and/or distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or taxes.
Investors should consider investment objectives, risks, charges and expenses carefully before investing. The prospectus and summary prospectus contain this and other information about the Funds and may be obtained by contacting your financial adviser, visiting our website at firsteaglefunds.com or calling us at 800.334.2143. Please read our prospectus carefully before investing. Investments are not FDIC insured or bank guaranteed, and may lose value.