Sprott Gold Equity Fund Manager Commentary Oct. 31, 2020
John C. Hathaway
Douglas B. Groh
The following commentary is an excerpt from the Sprott Gold Equity Fund Oct. 31, 2020, Annual Report.
October 31, 2020
Dear Fellow Shareholders,
The Sprott Gold Equity Fund’s (“Fund”) annual fiscal period (November 1, 2019, to October 31, 2020) marked nearly a full year under the new guidance of Sprott Asset Management LP. As you are aware, Sprott acquired what was formerly Tocqueville Gold Fund in January 2020, along with the portfolio management group that had managed the Fund since its launch in June 1998. For the 12 months covered in this report, the Fund appreciated 38.71%. This performance compares to a return of 47.93% for the PHLX Gold/Silver Sector Index (XAU), the Fund’s benchmark, over the same period.
The price of gold began the period under review at $1,513 per ounce (November 1, 2019), while equity markets continued to mark record highs and traded around the $1,500 per ounce level as the decade came to an end. Some of the themes that drove gold prices $200 per ounce higher during calendar 2019 included global monetary policies, the China-U.S. global trade war, low interest rates, record equity valuations, which also saw markets solidly support gold in the final days of December 2019. That support followed through into the new calendar year as Middle East tensions flared up and as the U.S. 10-year Treasury yield fell throughout January.
With the onset of the COVID-19 pandemic and its impact on global economies, gold saw investment interest broaden significantly as investors sought alternatives to traditional financial assets as global central banks drove interest rates lower in February and March. The market disruption in March and April initially saw gold prices sell off, but market participants quickly repositioned back into gold for its liquidity, security and diversification, as well as the financial insurance/hedge it provides as world governments mandated a global economic shutdown.
Gold prices moved somewhat sideways in May but then edged steadily higher throughout June into late spring and the beginning of summer, before stepping up in July, as the U.S. dollar broke down. Gold responded with a breakout of its own in late July, trading through the previous high of 2011 and set a new high at $2,064 per ounce in early August. Gold prices were range bound between $1,900 and $2,000 per ounce during much of August before backing off to around $1,880 per ounce in September. Consistent demand for physical gold and gold ETFs throughout the Fund’s fiscal year supported gold at the $1,900 per ounce level to finish the month at $1,879 per ounce (October 31, 2020).
Gold stocks followed gold bullion prices during the period, appreciating into the new year before dramatically correcting in March. The Fund experienced one of the best monthly performances it ever had, during the April recovery that started in late March and advanced into May before pausing briefly in late spring. As summer got underway, investors recognized that the gold price and the gold mining sector’s favorable financial condition would translate into improving profits in the coming year, unlike many stocks in the broader equity market. Gold stocks made a solid move throughout July and into August as the gold price broke through $2,000 per ounce, reaching a new intra-day high of $2,075 on August 7. As gold moved sideways in September and October, gold stocks followed suit. Still, investor interest in the sector broadened into the small-capitalization segment of the precious metals mining sector, while some of the larger-cap and more established mining companies felt confident to issue and increase dividends.
As of October 31, 2020, the Fund’s largest position was in physical gold, representing approximately 12.1% of the Fund’s total net assets. The Fund’s physical gold is vaulted outside the financial system, at a secure location and audited regularly. Our initial gold bullion position was acquired more than 15 years ago at an average cost of approximately $470 per ounce, well below current prices. Over the 12 months, gold bullion appreciated 24.18% compared to 38.71% for the overall Fund.
Gold and other precious metal securities issued by companies that are primarily engaged in mining or processing gold account for the rest of the Fund’s holdings, with 66.4% allocated to gold-related company stocks, 7.5% to silver-related company stocks and a small amount to cash (0.0%). While silver is used extensively for various industrial applications, it is also considered a monetary metal similar to gold and is often found with gold in precious metals ore deposits. During the second half of the year, silver stocks made a solid contribution to Fund performance. In July, silver broke out above $20 per ounce to trade just beyond $29 per ounce, after spending the last five years or so range bound between $15 and $20 per ounce. The Fund continues to emphasize exposure to small- and mid-capitalization precious metals mining stocks because their valuations offer greater long-term appreciation potential than companies that make up the PHLX Gold/Silver Sector Index (XAU), which is heavily weighted to large precious metals producers.
The Fund initiated positions during the past year in Saracen Mineral Holdings, a growing Australian-based gold producer and Bellevue Gold, an Australian developer. Sibanye-Stillwater was bought for the Fund for its favorable exposure to gold and the platinum group metals, in addition to a very strong balance sheet and potential for attractive dividends. SSR Mining was added to the Fund as the company merged with Alacer Gold, establishing a financially strong, diversified mining company with low-cost operations. Exposure to Pretium Resources was established to participate in the company’s improving outlook. Gold Fields was also added to the Fund’s portfolio as the company demonstrated a more profitable operating profile. The acquisition of Detour Gold by Kirkland Lake Gold closed in January 2020, which added to the Kirkland Lake Gold position already in the Fund. SEMAFO was acquired by Endeavour Mining in July 2020, and we increased our Endeavour position during that period based on the potential re-rating the new company should receive as a prominent west-African precious metals mining company. At the end of the fiscal year, Gatos Silver began trading in an initial public offering after the spin-out from Sunshine Silver Mining & Refining Corporation, which has been renamed Silver Opportunity Partners and continues to be a private company. Even though there were sizable gains and contributions to Fund performance from a number of Fund holdings such as Jaguar Mining, Franco-Nevada, Wheaton Precious Metals and B2Gold; there were also a number of Fund positions that held back performance during the year. These included Torex Gold, OceanaGold, Royal Gold and IAMGOLD. During the year, there were a number of positions sold for various reasons. In some cases it was to take profits or provide liquidity during the period. For some, they were sold because they offered limited upside or were poor performers. These included Almaden Minerals, Argonaut Gold, AngloGold Ashanti, ATAC Resources, Coeur Mining, Evolution Mining, Fresnillo, IAMGOLD, Ivanhoe Mines, Newcrest Mining, OceanaGold and Yamana.
The outlook for precious metals companies is very favorable and perhaps the best in more than forty years. Gold miners are realizing robust margins that are generating significant free cash flow which is allowing them to reduce debt and build cash on their balance sheets. Free cash flow yields have been rising over the past year from the low single digits (2-4%) to upper single-digit levels (7-9%), while it is not unusual for some companies to have free cash flow yields well into the double-digits (>15%). Meanwhile, mining companies are now in a position to provide generous dividends based on solid free cash flow, with numerous companies now posting dividends greater than the S&P 500 Index’s 1.6% yield. In addition to dividends, many mining companies are buying back their stock, which is unique for the precious metals mining sector and shows the confidence managements have in their operations and financial condition. Mergers and acquisitions activity, a prominent aspect of the precious metals mining sector and essential for many companies to either grow their business or replace mined resources, is likely to be more active in the coming year as COVID pandemic restrictions ease and with the industry’s profile of improving profits and strong balance sheets. As ever uncertainty remains and there is always a possibility of a downturn but that could also prove to be a good investment opportunity.
In our view, precious metals mining stocks represent an outstanding investment opportunity at the current moment because they combine the attributes of low valuation, robust financials and growth based on the excellent prospect for higher metals prices in the years to come. At the same time, the transition of the former Tocqueville gold investment team into the Sprott organization has been seamless and smooth. Our research capacity has been enhanced considerably with our integration into the Sprott network, which provides more in-depth analysis and information to support our investment decision-making. With an exceptionally bullish macroeconomic outlook for future gold and silver prices, we anticipate a continuation of good performance results in future years.
With best wishes,
John C. Hathaway
Senior Portfolio Manager
Douglas B. Groh
Senior Portfolio Manager
The views expressed above reflect those of John Hathaway and Doug Groh as of the date stated above and do not necessarily represent the views of Sprott Asset Management USA, Inc. or any other person in the Sprott organization. Any such views are subject to change at any time based upon market or other conditions and Sprott disclaims any responsibility to update such views. These views may not be relied on as investment advice and, because investment decisions for the Sprott Focus Trust are based on numerous factors, may not be relied on as an indication of trading intent on behalf of the Sprott Gold Equity Fund.
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Past performance is not a guarantee of future results. All data is in U.S. dollars unless otherwise noted. Sprott Gold Equity Fund invests in gold and other precious metals, which involves additional and special risks, such as the possibility for substantial price fluctuations over a short period of time; the market for gold/precious metals is relatively limited; the sources of gold/precious metals are concentrated in countries that have the potential for instability; and the market for gold/precious metals is unregulated. The Fund may also invest in foreign securities, which are subject to special risks including: differences in accounting methods; the value of foreign currencies may decline relative to the U.S. dollar; a foreign government may expropriate the Fund’s assets; and political, social or economic instability in a foreign country in which the Fund invests may cause the value of the Fund’s investments to decline. The Fund is non-diversified, meaning it may concentrate its assets in fewer individual holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility than a diversified fund.
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