Gold Investing 2020 with John Hathaway & Doug Groh
John Hathaway, Senior Portfolio Manager, explores why investing in gold makes sense for most investors and how it helps protect portfolios.
Why Gold Equities
Doug Groh, Senior Portfolio Manager, looks at how gold mining equities have been revitalized by improved managements and M&A activity.
John Hathaway, CFA®, Senior Portfolio Manager
John Hathaway: It's amazing. Things haven't changed significantly in terms of the long-term story, which has been in place for 20 years. What's changed is market recognition. Gold went into hibernation for six years after it peaked out in 2011 at $1,900, and since then, it's been basically backing and filling; I would say that it was in a big correction. What's changed is that investors are beginning to realize that there's no way out of easy money. Any attempt that has been made by the Fed [U.S. Federal Reserve] and other central banks to go on a tightening path has been met with a very severe negative reaction in financial markets, particularly in the stock market.
Gold is a Safe Haven Asset/The Yellow Metal was up +18% in 2019
John Hathaway: Gold has always been a safe asset. There's no counterparty risk. I'm not telling viewers anything they don't know. When you think about negative yielding cash in Europe, to me, it's a no-brainer to have some exposure here. Gold has always been a diversifier, a risk diversifier, a risk mitigator. Too many people think of it as a speculative investment. Gold has speculative aspects to it, but at its core, it's the safest asset you can have.
Gold is a Risk Diversifier/It Provides Superior Portfolio Protection
John Hathaway: Gold is a reserve asset that has liquidity seven days a week, 24 hours a day. The bid-ask is very, very narrow. It's extremely safe, extremely liquid, and I would say that in a world of very low yields, or negative nominal yields, and certainly in terms of negative real rates, it astounds me that more people don't gravitate to gold. But this is changing.
Bonds are always thought of as a safe asset. In my mind, they're one of the riskiest assets out there. I don't know what the trigger point is, but at some point, the Fed's attempt to keep a lid on short-term rates is going to run into headwinds.
$Trillions in Negative Yielding Debt/Bonds are Now a Risk Asset
John Hathaway: When that happens, the entire bond asset class is going to be vulnerable to rising rates. Negative nominal yields globally, I think the number is somewhere around $16 trillion. To me, the systemic risk that's represented by that number dwarfs what we saw in 2008 with the toxic mortgages.
The penalty for owning gold versus bonds is very low. If you had a decent free market level of interest rates, it would be a different story. But everything monetary policy is trying to do is suppress interest rates. That is why people are piling into bonds. That's why they are now probably more correlated with equities than they've ever been. Bonds are now a risk asset; they're not the safe asset they used to be.
Gold Allocation of 5%-10% Protects Investment Portfolios
John Hathaway: What's left? Basically, gold; it has to fill in for that lack of a safe asset. To me, having some significant allocation to gold like 10% will help protect your bond portfolio from the very real possibility that interest rates in our lifetime will start to rise. When that happens, there's going to be capital destruction that dwarfs what we saw in 2008.
WHY GOLD EQUITIES
Doug Groh, Senior Portfolio Manager
Doug Groh: We have seen revitalization in the equity space over the last year with several mergers and property sales. We're seeing investors becoming more intrigued with the dynamics that are underway in the gold sector, whether it's M&A (mergers and acquisitions) or the cash flow, and gold mining companies are in a really good position right now to generate significant cash flow.
Gold Miners are Much Healthier/Balance Sheets Have Improved Substantially
Doug Groh: Over the last few years, gold mining companies have been cutting back on costs, focusing better on projects and getting their capital allocation in a much better position than they were, say seven, eight years ago. This has resulted in an expansion of the gold price last year or so, with gold moving more than $200 an ounce. The margins for gold companies are really quite spectacular and are likely to continue for the next four or five years as investors recognize that there's significant cash flow generation here.
When we're looking at gold mining companies to invest in, we're looking at several different aspects. This includes their resources and assets, and financials and balance sheets.
Management Teams are Key/Help Define the Equity Investment Opportunity
Doug Groh: But one of the key aspects of a company's success is its management team. One has to understand what management's trying to do, perceive what they're able to achieve and accomplish, and then recognize the challenges as well as the opportunities. Investors can learn what management's doing and what their strategic approach is in allocating capital, their discipline with their assets, their focus on return, as well as their approach to risks. All these things come together for us in terms of understanding the investment opportunity for our clients. Having the conversation and interaction with management is critical to understanding how a company is going to perform in the future.
M&A in the Gold Sector
Doug Groh: The M&A market in the gold mining space is quite dynamic and active on an ongoing basis. This past year, we've seen some large transactions that included Barrick, Newmont, Randgold and Goldcorp. However, we're also seeing smaller companies come together and look at either buying properties or merging with other similar-sized companies.
M&A is Moving into the Junior Space
Doug Groh: The dynamics in the junior space are very interesting. In particular, there is concern about liquidity. Mid-sized companies don't necessarily have the recognition in the marketplace or the liquidity at their current size, so they're seeking out a partner or greater scale so that they can achieve that liquidity and recognition in the marketplace.
Another dynamic is that mining companies do deplete their resources and must replace those resources either through more exploration or development or alternatively through M&A. This is a large driver of what's going on in the marketplace right now.
Several positive things are going on, and I think companies are recognizing that being a single asset company is not quite as attractive to the marketplace as having multiple assets in multiple jurisdictions. This is forcing mid-cap to smaller-cap companies to seek out ways to become more relevant in the marketplace, in order to improve their asset quality and perception in the market.
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