The price of precious metals, gold in particular, has been influenced by a wide range of economic and political factors. As a result, price momentum has been intermittent and in decline since the beginning of the year.
Among these factors are the prospects of slower global economic growth; market volatility; low interest rates in the U.S. and other developed economies; trade tensions between the U.S. and China and, to a lesser extent, the European Union, Canada and Mexico; turmoil surrounding Britain’s exit from the European Union; and geopolitical risks in the Middle East.
These factors have all, at some point during the year, caused investors to reassess their expectations and either head for the safety of gold bullion or sell their investments in the metal, triggering upward and downward movement, respectively, in price.
But, in spite of periodic gyrations, the prices of precious metals have trended upward throughout the year, contributing to the strong performance of precious metals equity mutual funds so far in 2019. But worth noting is that the prices of precious metals are not necessarily always correlated to the performance of the stocks of the companies within the precious metals sector, as some companies may perform relatively well even when prices are dropping.
There have been some significant price increases this year: gold, which began the year at $1,282.90 an ounce, reached a high for the year of $1,546.10 on Sept. 4; silver climbed to a high of $19.31 an ounce on the same day, up from $15.44 at the beginning of the year; platinum, which began the year at $785 an ounce, reached a high for the year of $977 on Sept. 4; and palladium rose to a high (as of press time) of $1,676 an ounce on Oct. 2, up from a starting price at the beginning of the year of $1,267. (All prices are the London spot fix price in U.S. dollars.)
Gold, which is widely regarded as a store of value and a hedge against inflation, is the most actively traded precious metal. It is seen as a mainstream investment that has low correlation to other major asset classes, with liquidity comparable to that of equities. Silver, platinum and palladium, on the other hand, while also seen as stores of value, have more of an industrial value and are not as widely traded as gold. Instead, their prices tend to be leveraged to gold. For these reasons, precious metals mutual funds usually have their largest exposure to the yellow metal.
Lower interest rates and negative real yields, combined with tighter monetary policies in developing countries and regions such as the U.S., Japan and Europe, provide a tailwind for higher gold prices, says Benoît Gervais, senior vice president, investment management, and head of the resources portfolio team at Mackenzie Investments in Toronto. Other factors include slowing global economic growth and continuing trade wars.
Gervais, portfolio co-manager of Mackenzie Precious Metals Class fund together with team member Onno Rutten, vice president, investment management, says the fund provides direct exposure to precious metals as well as to companies that produce or supply precious metals.
Precious metals act as insur- ance against volatility and economic uncertainty, Gervais says, and as an alternative to traditional equities and fixed-income investments. He recommends investors hold 5%-10% of their portfolios in precious metals to enhance risk- adjusted returns and achieve greater diversification, as precious metals are not correlated to other major asset classes. He says the average Canadian investor has only 3% exposure to gold.
However, rising gold prices alone should not be the reason to buy gold, Gervais cautions. Investors should ask: “Rising relative to what?”
“We don’t know where asset prices are heading,” Gervais says, and if you factor in the contention that “an accident is waiting to happen” in the markets, then holding a portion of clients’ portfolios in precious metals may be a prudent choice. Over any 10-year period, he says, there is always a dislocation somewhere, and the “insurance policy” can be cashed in if clients need money.
The Mackenzie fund had $311.1 million in assets under management (AUM) as of Aug. 31. The portfolio comprises securities that are diversified by type of metal, including gold (76%), silver (7%) and other precious metals (9%). The fund also invests directly in gold bullion.
The Mackenzie fund’s portfolio is geographically diversified, with 63% of AUM held in Canadian securities, 16% in Australia, 9% in South Africa and the remainder in countries such as Zambia, Peru and Belgium.
The Mackenzie fund primarily holds “companies in the larger mid-cap space, which have the balance-sheet and portfolio depth to generate sustainable free cash flow over time,” says Rutten. This allows the companies to reinvest in their mines and new projects to offset resources depletion that typically occurs in the mining industry. Over a full cycle, Rutten says, these companies should generate value for the fund’s unitholders.
The exposure to mid-cap companies is complemented by larger companies for greater portfolio stability and reduced volatility, Rutten says. The Mackenzie fund also invests in small-cap exploration companies because, Rutten says, “value is created first and foremost at the drill bit.”
As well, the Mackenzie fund holds gold bullion because gold producers have a leveraged exposure to gold bullion. “For every 1% bullion rises,” Rutten says, “the stock [prices] of these companies go up by 2%.”
One of the Mackenzie fund’s largest exposures is to Detour Gold Corp., a Toronto-based mid-cap gold producer with a unique 20-year mine life and a solid balance sheet and which operates in a stable jurisdiction. The company had operational and governance issues a few years ago, but now has a rejuvenated management team.
Another major holding of the Mackenzie fund is Gold Fields Ltd., one the largest gold producers in the world, headquartered in South Africa. Rutten says that the company had the ability and foresight to invest in growth projects when gold bullion’s price had dropped to $1,200 an ounce and other companies chose not to invest in the sector. Now, Gold Fields is “entering the cycle with rising production,” Rutten says.
Having invested in companies with good, long-term growth potential, the Mackenzie portfolio managers have not made any significant changes to the fund’s portfolio for the year.
Looking ahead, Rutten says, “low interest rates are positive for gold prices. It’s unlikely that central banks have a lot of room to raise interest rates [and they] will more likely lower rates.”
Like Gervais, Brahm Spilfogel, vice president and senior portfolio manager, global resources, materials and energy team, with RBC Global Asset Management Inc. in Toronto, believes that trade wars and the level of real interest rates are among the main drivers of precious metals’ prices.
Spilfogel, a member of the portfolio management team of RBC Global Precious Metals Fund, says precious metals equities are expected to benefit from the trend toward lower rates in the U.S.
“Although far-fetched, the prospect of negative rates in the U.S. is sneaking into the psyche of people,” Spilfogel says. In Europe, for example, where interest rates are negative, investing in gold is a good option because investors technically have to pay banks to hold their money, he adds: “Gold is a safe place for people looking to invest in real assets to put their money. It is proven insurance.”
However, Spilfogel foresees the outcome of the 2020 U.S. election will be an emerging risk for precious metals. If Donald Trump is re-elected, Spilfogel says, there is likely to be continued uncertainty, which in turn benefits precious metals. If the Democrats win, sentiment toward precious metals could turn negative in the short-term, but improve in the long term.
The precious metals market currently is pricing in a soft landing for the U.S./China trade tensions. “If there is real capitulation on threats of tariffs,” Spilfogel says, “the near-term risk will be ratcheted down.” However, the opposite will be true if tariffs are implemented.
The RBC fund had $685.9 million in AUM as of Aug. 31. Its holdings are diversified globally and comprise companies that are involved in exploration, mining and production of precious metals, either directly or indirectly. The fund also invests in bullion, coins, receipts and certificates.
The focus is on high-quality companies with superior assets, disciplined management and ability to generate free cash flow.
Spilfogel says small- and mid-cap companies compose the largest component of the portfolio, while investments in large-cap companies focus on the “best available opportunities.” Small- and mid-cap companies must have strong management teams, the ability to finance production “in a flat commodity environment and be able to profitably grow reserves in the ground” and must be able to generate “high returns on invested capital.” In addition, companies held by the fund must be operating in “better jurisdictions,” have a high probability of success and be able to build out their resources on budget and on time.
A large portion of the RBC fund’s portfolio (79.2%) is invested in Canadian assets, with 8.6% in the U.S., 4.8% in Côte d’Ivoire and the remainder in Australia and New Zealand. As for asset type, says Spilfogel, “more than 70% of the portfolio is allocated to gold, roughly 10% is in silver and the remainder is in platinum and palladium.”
One of the RBC fund’s largest holdings is Kirkland Lake Gold Ltd., which Spilfogel describes as “one of the best-performing stocks in the portfolio over the past few years, rising from about $4 to $55 [a share].” The company, which has producing mines in northeastern Ontario and Australia, “meets our criteria of superior assets in better jurisdictions.”
Another major holding is Endeavour Mining Corp., with mining operations in Côte d’Ivoire and Burkina Faso. The company – “now in harvest mode” – has a world-class exploration team backed by solid management and a “great construction team,” Spilfogel says.
Spilfogel has not made any major changes recently to the portfolio but, he says, “we have taken profits in certain stocks,” such as Kirkland Lake.
Spilfogel adds that the backdrop for gold is positive: “For seven years, the sector has been going down to sideways. But it looks like we are making our way out of that [trend].”