Precious metals are shining brightly this year as real interest rates sink and investors look for safe havens.
Although gold bullion pays neither interest nor dividends, it tends to perform best when real interest rates are negative relative to inflation, as they are now. Officially, inflation is benign — running at slightly less than 2% in Canada and the U.S. — but the yield on the bellwether 10-year U.S. treasury bond had shrivelled to a minuscule 0.68% as of Oct. 1.
In addition, tax cuts and rising government expenditures around the globe, designed to counter the economic effects of Covid-19, have contributed to a surge in government borrowing and soaring deficits. History shows that skyrocketing debt and unbridled government spending ultimately erode the value of paper currency. When currencies lose purchasing power, precious metals and other hard assets tend to do well.
Robert Cohen, vice president and portfolio manager with Toronto-based 1832 Asset Management LP and lead manager of Dynamic Precious Metals Fund, says gold bullion’s price was strengthening before Covid-19 hit in March, but the onset of the pandemic and subsequent burst of global monetary and fiscal stimulus added fuel to bullion’s ascent.
“We’re seeing declining purchasing power across all global currencies,” Cohen says. “Interest rates are low and there is a massive amount of debt. Governments are likely going to have to inflate their way out of debt.”
The gold bullion price hovered just over US$1,915 an ounce at the start of October after a strong run in August that saw the price cross the US$2,000 mark from a March low of US$1,452. Weakness in the economic outlook and the ongoing need for government stimulus is likely to propel gold higher over the longer term, Cohen says.
“We’re seeing growth in both investor and central bank demand for gold,” Cohen says. “Gold is being accumulated to protect purchasing power. Gold stocks have risen, but they are still cheap relative to net asset values and the underlying gold bullion price.”
Cohen points to the value of gold as a portfolio diversifier and notes that gold has a low correlation to other financial asset classes. “The broader stock market has had an incredible run,” he says. “If there is any doubt that it can keep going, investors should diversify. Gold — through bullion or equities — is a good choice.”
Investing in gold companies is a “stock-picker’s game,” Cohen says. He points to the Dynamic fund’s strong performance relative to its benchmark index. As of Aug. 31, the fund’s F Series had a one-year gain of 68.2%, handily beating the 51.5% return of the benchmark Dow Jones precious metals total return index (in Canadian dollars). The five-year average annual compound return of the fund was 33.5%, also superior to the 27.1% of the index.
Cohen, who formerly worked in the field as a mining engineer, likes to model company scenarios from the ground up to determine value. He sees some of the best opportunities in mid-sized companies. “Some of the senior companies have a history of non-accretive M&A activity,” he says. “There’s been some lousy due diligence in the past and overpaying for assets — especially undeveloped assets, where there was a tendency to paint a picture of a deposit that was much better than it actually turned out to be.”
A handful of the better senior companies have fixed their mistakes and cleaned up their balance sheets, Cohen says. Only five companies in the Dynamic fund, which holds about 45 companies, overlap with the S&P/TSX global gold index, he says, and there are many unfamiliar names.
About 42% of the Dynamic fund’s assets under management are Australia-based companies and 58% are Canada-based, but properties can be located anywhere. There also is a smattering of West Africa-based holdings. Roughly half of the portfolio is invested in companies with mines in production, while the other half focuses on exploration and development plays. “We look for the projects that truly excite us,” Cohen says. “That pushes us to ‘development’ companies. We’re looking for the mines of tomorrow.”
A key holding is Northern Star Resources Ltd., an Australia-based company that concentrates on acquiring existing operating mines from other companies and making them more efficient.
“Northern Star’s senior management team is stacked with engineers and geologists — unlike some other companies, where senior management lacks technical expertise,” Cohen says. “[Northern Star management] knows how to grab the bull by the horns and turn a tired operation around.”
Another top holding is Toronto-based Agnico-Eagle Mines Ltd., where management is skilled at building mines as well as acquiring mid-sized companies with promising properties, Cohen says.
The Dynamic fund holds a few silver companies, which Cohen calls “the pepper on the salad.” One holding is SilverCrest Metals Inc., which has a world-class discovery in Mexico.
Benoit Gervais, senior vice president, investment management, portfolio manager and head of the resource team at Toronto-based Mackenzie Investments, along with Onno Rutten, vice president and portfolio manager, have guided Mackenzie Precious Metals Class to index-beating returns using careful stock-picking. At Aug. 31, the fund boasted a one-year gain of 56.9% and five-year average annual return of 30.5%.
Gervais and Rutten also view gold as a valuable investment diversifier and a viable alternative for a portion of a balanced portfolio’s fixed-income segment at a time when interest payments are paltry and real yields are negative. The portfolio managers suggest a 10%–15% allocation to gold is a sound strategy by investors to smooth volatility and maintain purchasing power.
“There is no end in sight to government stimulus measures,” Gervais says. “As long as real interest rates are in negative territory, we anticipate 15%–20% annual appreciation in the gold bullion price on average.”
Gervais and Rutten say governments need to keep borrowing and will keep suppressing interest rates. As countries all around the world deal with the pandemic, borrowing rather than taxation seems to be the preferred solution for economic rescue. Furthermore, unprecedented stimulus is likely to continue in the U.S. no matter who wins the November election.
“Governments are spending — not only on rescue packages, but on education, health care and green infrastructure — and they were spending heavily even before the Covid virus hit,” Rutten says. “The pandemic has merely accelerated what was happening already.”
While gold stocks suffered a sharp correction along with broad stock markets in March, when Covid-19 was declared a pandemic, the gold sector recovered quickly and proved its value as a shock absorber, Rutten says.
The long-dormant junior mining sector has seen particularly exciting returns recently. A third of the stocks held by the Mackenzie fund are junior exploration and development companies, a third are mid-sized producers and a third are senior companies.
Typically, the Mackenzie fund holds 40 to 80 companies, and now is at the high end of this range.
Geographically, about half the holdings are based in Canada, followed by 16% in Australia, 12% in South Africa and 7% in the U.S. “We are jurisdiction-agnostic,” Gervais says. “We concentrate on the quality of the assets, the expertise and discipline of the management team, the political environment and [environmental, social and governance] factors. Mining companies need the support of local communities.”
The Mackenzie fund’s mandate permits 10% exposure to bullion, which is being fully utilized. Bullion prices tend to be more stable than stock prices on both the upside and downside, providing ballast to the portfolio.
A key stock in the large-cap space is Gold Fields Ltd., based in South Africa but with international operations, including properties in Australia and South America. In Australia, Gold Fields is partnering with Gold Road Resources Ltd. — another holding in the Mackenzie fund — to build a mine.
In the mid-cap arena, a top holding is Saracen Mineral Holdings Ltd., an Australia-based producing company with efficient mining operations, leading to cash-flow growth.
A recent purchase is Australia-based De Grey Mining Ltd., which made a promising discovery in a previously underexplored part of that country using new geological techniques.
True value creation comes from discovering more gold, Gervais says, which is why the Mackenzie fund invests actively in a portfolio of juniors.