Gold has rallied as stock prices have fallen. In this brief commentary, Portfolio Manager Thomas Kertsos and Research Analyst Max Belmont reflect on gold’s recent performance and offer their insights into current trends.
What recent changes have you seen in the gold market?
In the first weeks of 2016, concerns about a steeper economic slowdown in China and a possible banking crisis in Europe drove the US stock market1 down around 11% and gold up 15%–18%.2 For the first time in recent years, bad news for the economy was bad news for stocks and generally good news for gold. It is this inverse relationship that makes gold a potential hedge against disruptive economic events. So far this year, gold has performed in line with its traditional role as a potential hedge, both in the United States and, to an even greater degree, in weaker economies—such as Brazil and South Africa—where currencies are under stress.
Does this mean the bear market for gold is coming to an end?
We don’t forecast the price of gold. We believe that there are simply too many variables involved—the state of the economy, monetary policy, real yields, currency trends, stock prices—and that the interactions among these factors are too complex to construct a credible forecast. That’s why predicting the price of gold lies outside our philosophy.
Why should anyone consider an asset whose future price is unpredictable?
We believe gold should be held as a potential hedge against extreme market outcomes. If the real price of gold is going up, something else is likely going down. Investors owning gold for the right reason and in the right amount, based on their investment profile, should be untroubled if the price of gold goes down. Historically, when this has happened, equities or other parts of investor portfolios have generally done well. The key is to have the right capital allocation process. At the same time, we are mindful of certain factors that may support the price of gold. There have been few significant gold discoveries since the 1990s, and, according to at least one analysis, gold production peaked in 2015.3 Even if demand is volatile and hard to forecast, the supply situation for gold bullion in the coming years should be supportive of the price.
Who has been buying gold?
The sources of recent gold buying have been varied. ETFs have purchased about $10.6 billion of gold by the end of February.4 In the futures market, there has been significant short covering in 2016, but more recently, outright long positions have also been increasing. The Chinese New Year accounted for a seasonal increase in demand in December and January, but we believe it was not responsible for the significant buying activity that we saw in
February. Thus far, central banks have not been significant buyers of gold bullion this year. Here, too, we don’t try to make predictions. Buying by central banks can certainly support the price of gold, and according to the World Gold Council, central banks transitioned in 2010 from being net sellers to net buyers of gold, but their behavior is too unpredictable to serve as a basis for forecasting gold bullion demand trends and investing in gold.
Headlines around solvency and overall business quality for miners have been negative. What are the implications for investors?
When we assess businesses, we focus on several criteria, like the quality of a company’s assets and its cost profile. We analyze the balance sheet and cash flow generation very carefully, as well as the operational execution and the capital allocation of the management team. And we also apply detailed mine-by-mine valuation analysis to try to find the cheapest and highest-quality ounces available. Some of our key holdings include, for example, one company with good exploration potential, a very low cost-structure, low capital intensity, strong free-cash-flow generation, low debt and excellent management, in our view. Another company has significantly growing output, one of the lowest-cost operations globally and enormous land ownership. Yet another has signed high-quality royalty deals and has a low cost structure and little, if any, debt. In other words, even in an environment where many miners have come under pressure, careful fundamental analysis can uncover attractive entrance points into some gold miners. We always ask which businesses will come out of this downturn stronger and which management teams have added value over the last years but have been unappreciated by the market. We believe that some gold mining businesses are in far better shape now than they were before this downturn started in 2011.
How do lower commodity prices affect gold miners’ costs?
In several countries, miners pay for a significant part of their capital projects and operating costs (excluding energy) in local currencies. While lower energy prices have generally been helpful to miners, the greatest impact on their costs has come from weaker local currencies in countries where some mines are located.
The use of hedging techniques is speculative and there can be no assurances any hedging technique will be effective. Investment in gold and gold-related investments presents certain risks, including political and economic risks affecting the price of gold and other precious metals, like changes in US or foreign tax, currency, or mining laws; increased environmental costs; international monetary and political policies; economic conditions within an individual country; trade imbalances; and trade or currency restrictions between countries. The price of gold, in turn, is likely to affect the market prices of securities of companies mining or processing gold, and accordingly, the value of investments in such securities may also be affected. Gold-related investments as a group have not performed as well as the stock market in general during periods when the US dollar is strong, inflation is low, and general economic conditions are stable. In addition, returns on gold-related investments have traditionally been more volatile than investments in broader equity or debt markets.
The 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 80% coverage of U.S. equities, it is also considered a proxy for the total market. The Standard & Poor’s 500 Index includes dividends reinvested. One cannot invest directly in an index.
The commentary represents the opinions of Thomas Kertsos, portfolio manager of the First Eagle Gold Fund and senior research analyst, and Max Belmont, research analyst, as of March 9, 2016, and is subject to change based on market and other conditions. The opinions ex-pressed are not necessarily those of the entire firm. These materials are provided for informational purposes 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. Past performance does not guarantee future results.
