Market Overview
The price of gold rose 12.9% in the second quarter of 2020, as global monetary and fiscal stimulus measures intended to counteract the effects of the Covid-19 pandemic continued to weigh on real interest rates; historically, low real rates have been favorable for the price of gold. Policymakers moved quickly and aggressively to reduce the economic impact of the virus; even in early June, when data suggested that the economic recovery was proceeding more rapidly than expected, they appeared more inclined to enlarge stimulus packages than to reduce them. Later in June, a resurgence in the virus in some regions raised fears that the resumption of economic activity could be delayed.
Although equity markets were largely buoyant in this period, we did not share the prevailing mood of optimism. We do not know what the future will bring, but we are concerned about macro-economic and geopolitical risks that seemed to be widely ignored by investors. We think, for example, that sovereign debt is growing at an alarming pace around the world without any signs of abatement. According to the International Monetary Fund, total global public debt as a percentage of GDP now exceeds its level during World War II, and the Congressional Budget Office projects that the federal deficit in the United States will approach 18% of GDP in fiscal 2020. Geopolitical tensions remain high in Hong Kong, Iran, Syria, North Korea and other possible flash points. Meanwhile, the European Union, which lacks a coordi-nated policy for offsetting the pandemic’s economic damage, is beset by infighting that leaves highly indebted countries like Italy particularly vulnerable. Further, European banks’ profits—and thus the region’s financial stability—appear particularly suscep-tible to the headwinds of ongoing low interest rates. We are keeping a close eye on financial, monetary and political develop-ments in continental Europe.
In June, the National Bureau of Economic Research made offi-cial what most observers had intuited: The US economy entered recession in February, as the Covid-19 outbreak began to inten-sify on these shores. From a global perspective, pandemic-related shocks to supply and demand are expected to result in a recession of historic proportions. The World Bank is forecasting that more than 90% of the world’s economies will be in recession in 2020, which would represent the most broad-based contraction of the past 150 years.
Recessions historically have been very positive for the price of gold over the medium to long term, though it’s not unusual to see the price drop in the early stages of a contraction, as we did during both first quarter 2020 and fourth quarter 2008 at the onset of the global financial crisis. The potential hedge value of gold has tended to reassert itself as liquidity fears subside, however; we saw this in the recovery of gold’s price starting in late March this year and even more powerfully in the years following the global financial crisis as the gold price ultimately doubled its fourth quarter 2008 level.
Against the current uncertain backdrop, gold has demonstrated its value as a long-duration potential hedge against adverse circumstances. While gold mining companies were not immune to the disruptive effects of the virus, their financial performance generally proved to be resilient. We think this can be attributed in part to the uncommon geography of the mining business. With most mines in isolated locations—including regions that have been threatened by Ebola, tuberculosis and other health crises—operators have long been motivated to maintain on-site medical infrastructure and comprehensive health protocols, which have provided them with the tools and experience neces-sary to stage a coordinated response to the risks posed by Covid-19.
The fact that the gold price advanced strongly in the second quarter does not, of course, guarantee that further gains lie ahead. We do not presume to predict the price of gold; it has been volatile historically, and we see no reason for it to be less so in the future. But regardless of such short-term variability, we believe the performance of gold thus far in the Covid-19 crisis has reaffirmed its utility as a potential hedge against “black-swan” events. Furthermore, on the basis of real interest rates, gold has rarely been more attractive than it is today. With sovereign yields broadly negative across the curve on an inflation-adjusted basis—and in many cases, including Europe and Japan, on a nominal basis as well—the opportunity cost of gold ownership is minimal.
Portfolio Review
Gold Fund A Shares (without sales charge*) posted a return of 39.99% in second quarter 2020. All geographic regions contrib-uted to performance in what was a particularly strong period for gold-related equities, while gold bullion also gained. The Gold Fund underperformed the FTSE Gold Mines Index in the period.
The leading equity contributors to performance in the second quarter were Barrick Gold Corporation, Newmont Corporation, gold bullion, Wheaton Precious Metals Corp and B2Gold Corp. The gold mining industry in general has proven to be resilient through the operational disruptions related to the Covid-19 pandemic, partly due to mining companies’ experi-ence managing previous health crises that affected the regions in which they operate
Barrick Gold (TSX:ABX, Financial) has continued to execute through the challenges posed by the pandemic, with strong production results and low costs driving improved free cash flow reported for first quarter 2020. Barrick has drawn on previous management experience with Ebola outbreaks in Africa to formulate a plan to promote the safety of its employees and communities in the face of Covid-19. The company has maintained its annual production guidance for 2020 with only a slight downward adjustment, due to a lease dispute with the government of Papua New Guinea. We believe the company’s prudent management team and strong and diver-sified asset base position it well to manage through the current trying environment.
Given what we view as a high-quality management team and robust balance sheet, Colorado’s Newmont (NEM, Financial) is a prime example of a miner that was prepared to meet the challenges of Covid-19. With rigorous protocols already in place, the company has been proactive in managing its mines to protect local communi-ties and infrastructure while at the same time mitigating the pandemic’s impact on its business. In contrast with broad market trends that have companies cutting or suspending dividend payments, Newmont recently increased its quarterly dividend by 79%.
Gold’s recovery from its brief mid-March swoon continued in the second quarter, sending the price of the metal to a new seven-year high in nominal US dollar terms; meanwhile, nominal gold prices established all-time highs in all the other currencies we track. With the extraordinary policy accommodation introduced to combat the impacts of Covid-19 unlikely to be unwound anytime soon, we expect the quality of man-made money to continue to deteriorate. If so, it would highlight gold’s historical role as a long-duration potential hedge against the myriad risks facing investment portfolios.
Holdings that contributed least to the fund’s quarterly perfor-mance included Dundee Precious Metals Inc. equity warrants expiring 5/13/21, Pan American Silver Corp. contingent value rights expiring 2/22/29, Industrias Peñoles SAB de CV, Orla Mining Ltd. and Kinross Gold Corporation. Because of the strength of gold-related securities during the period, none of these investments actually detracted from fund performance— they just contributed less than other fund holdings.
In mid-May, First Eagle participated in a secondary offering by Dundee Corporation (TSX:DC.A, Financial) to sell a portion of its interest in subsidiary Dundee Precious Metals (TSX:DPM, Financial); each unit sold consisted of one common share of Dundee Precious Metals and one-half of a common-share purchase warrant. Though the price of these warrants went up sharply, their very small average weighting in the portfolio during the period translated into only a very small contribution to performance. We believe Dundee Precious Metals is well positioned for the current gold market environ-ment given its strong cash flows.
Pan American Silver (TSX:PAAS, Financial), a Canadian silver miner with operations concentrated in Latin America, is the world’s second largest primary silver producer. These contingent value rights were part of the consideration paid by Pan American to Tahoe Resources shareholders upon acquiring that company in 2019. The value of the rights increased significantly during the quarter alongside the price of silver; as our ownership of these securities represents only a small percentage of the portfolio, their contribution to perfor-mance was relatively minor.
Mexican mining group Peñoles (MEX:PE&OLES) produces a range of precious and industrial metals, but gold and, to a lesser extent, silver account for the majority of its revenue. Peñoles’ stock posted a strong return during the second quarter, but it’s relatively small allocation within the fund prevented it from being significantly additive to performance.
We appreciate your confidence and thank you for your support.
Sincerely,
First Eagle Investment (Trades, Portfolio) Management, LLC
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 princi - pal 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 www.feim.com or by calling 800.334.2143. The average annual returns for Class A Shares “with sales charge” of First Eagle Gold Fund give effect to the deduction of the maximum sales charge of 5.00%.
There are risks associated with investing in securities of foreign countries, such as erratic market conditions, economic and political instability and fluctuations in cur-rency exchange rates. These risks may be more pronounced with respect to investments in emerging markets.
Investment in gold and gold related investments present certain risks, including political and economic risks affecting the price of gold and other precious metals like changes in U.S. 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 U.S. 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. Investment in gold and gold related investments may be speculative and may be subject to greater price volatility than investments in other assets and types of companies.
Funds whose investments are concentrated in a specific industry or sector may be subject to a higher degree of risk than funds whose investments are diversified and may not be suitable for all investors.
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 portfolio is actively managed and holdings can change at any time. Current and future portfolio holdings are subject to risk.
