How to play gold if the precious metal’s price really starts to shine

Russ Mould
25 June 2019

“The prospect of looser central bank policy, concerns over global growth and unrest in the Middle East are all giving gold a boost, thanks to its perceived status as a store of value and a haven asset during times of uncertainty. But what is really getting gold-watchers excited is a break-out on the metal’s price chart above the $1,350-to-$1,360 an ounce mark that had capped its advance several times in the past five years,” says Russ Mould, AJ Bell Investment Director.

 
Source: Refinitiv data

“The latest price surge does seem to coincide with expectations that the US Federal Reserve will start to cut interest rates, thanks to pressure from President Trump, spotty economic data in areas such as housing and car sales in America and the central bank’s own fears about how the President’s trade and tariff policies will play out. 

“The Atlanta Fed expects US GDP growth of 2.0% on an annualised basis in Q2 and the New York Fed just 1.4%, against 3.1% in the first three months of this year.

“That is hardly a disaster (even if such rates of increase undershoot the President’s 3% target) but if events take a turn for the worse and the Fed reaches for interest rate cuts or even more Quantitative Easing then gold             could continue to thrive. Such policies would probably be a response to economic weakness and gold has tended to do well during downturns or recessions.

“It soared from $672 to $1,096, for example, during 2007-09 when the American and global economies fell off a cliff and the US Federal Reserve responded with interest rate cuts and Quantitative Easing (and then kept going higher). The precious metal also thrived during the recessions (and stock market downturns) of the early 1970s and early 2000s.

 
Source: Refinitiv data

“For those investors who feel that history could repeat itself (even if there is no such guarantee) this raises the issue of how best to invest and use gold as part of a diversified portfolio designed to provide downside protection and scope for upside gains.

“The good news is that investors have plenty of choice. They can either buy the physical metal (directly or indirectly); they can buy individual mining stocks; or they can buy funds which specialise in precious metal miners and, in return for a fee, do all of the donkey work when it comes to researching and selecting the gold miners to buy.”

Gold

“A number of exchange-traded funds (ETFs) and trackers are designed to follow the gold price and provide investors with gold’s performance, minus the fees of running the funds. This spares investors the costs and inconvenience associated with issues such as storage and insurance when it comes to holding physical gold coins or bars and offers exposure to the gold price. The trackers will move pretty much lockstep with the underlying metal price, although this does mean that they can follow it down as well as up.

“Investors may also wish to choose between those trackers which actually own the physical gold to provide performance and those which use futures contracts and derivatives instead. ETFS Physical Gold or iShares Physical Gold, for example, own the metal while ETFS Gold ETC uses derivatives.”

Individual gold miners

“Gold mining shares can rise very sharply in value as the gold price rises but they can drop like a rock when it falls, so they are a high-risk, potentially high-return option. And sometimes they can do badly even when gold is rising, as Avesoro Resources’ appalling share price performance in 2019 can attest, thanks to missed production targets and industrial unrest at its West African mines.

“The intriguing thing here is that gold stocks have done badly for a long time (because gold has done nothing or worse) but gold mining bosses seem to think that there is some value to be had as a result.

“America’s Barrick Gold acquired then-FTSE 100 member Randgold Resources in a $6 billion all-stock deal in January and straight afterwards Newmont Mining swooped for GoldCorp in a $10 billion cash-and-stock deal. Newmont and Barrick then forged a joint-venture in Nevada and Barrick is now offering to acquire the final 36% stake in Acacia Mining to take it back to full ownership. On a smaller scale, Canada’s Hunt Mining launched a bid for AIM-quoted Patagonia Gold in May.

“The world’s biggest gold miners are listed on the Toronto or New York Stock Exchanges in the form of Newmont Goldcorp and Barrick Gold. London’s biggest gold miner, Randgold, was acquired by Barrick last year, although FTSE 100 silver miner Fresnillo does produce some gold too.

“It is still possible to research a wide range of gold miners that trade on either London’s Main Market or the junior AIM platform. The biggest is now FTSE 250 member Centamin, which has a market cap of £1.3 billion, followed by Acacia Mining at £784 million and AIM-quoted Highland Gold at £766 million, while some of the AIM plays are tiddlers such as Galantas Gold (market cap £13 million) and Cora Gold (£5 million).

“Bizarre as it sounds, sitting on a gold mine is not a guarantee of riches or stock market success, as the share price performance of the gold miners that form part of the FTSE All-Share or AIM All-Share indices shows. There is a huge range of share price gains and losses in 2019 alone:

Gold miner

Share price performance to date in 2019

Trans-Siberian Gold

+122.0%

Serabi Gold

+103.0%

Ariana Resources

+63.9%

Petropavlovsk

+57.5%

Beowulf Mining

+57.0%

Great Western Mining

+52.8%

Highland Gold

+47.4%

Shanta Gold

+31.5%

Centamin

+7.3%

Chaarat Gold

+4.8%

Acacia Mining

+4.1%

GoldStone Resources

+2.9%

Scotgold Resources

+2.6%

Griffin Mining

+2.3%

Greatland Gold

(9.1%)

Hummingbird Resources

(14.7%)

Cora Gold

(17.7%)

Bezant Resources

(21.7%)

Goldplat

(23.0%)

Galanta Gold

(24.3%)

Patagonia Gold

(30.5%)

Condor Gold

(31.5%)

Kodal Minerals

(33.3%)

Vast Resources

(60.3%)

Avesoro Resources

(60.5%)

Wishbone Gold

(78.6%)

Source: Refinitiv data, based on gold miners that are part of either the FTSE All-Share or FTSE AIM All-Share indices

“This goes to show that investors must do their research before they take the plunge on a gold miner because things can and do go wrong. Key factors to study include:

•        The miner’s status. Some miners are producing gold, some are exploring a site and some are prospectors that may have no more than a licence to mine and are still doing preliminary geological work. The more mature the miner, the less risky it will be. Although the greater gains could be had among the juniors if one makes a big discovery or starts to ramp-up production the risks here are enormous and the scope for something going wrong and share price losses considerable. Investors also need to assess the miner’s management team and whether it has the right skills and local connections and a decent track record.

•        Geopolitical risk. “Resource nationalism” can be an issue, should a local government decide it wishes to keep more of its mineral riches for itself and impose higher taxes or take away a licence.

•        Operational risk. Mines rarely run smoothly and their location – in the desert, the jungle or mountains – and issues such as local labour skills and availability and even the weather must be taken into account.

•        Financial risk. Many miners take on a lot of debt when they first develop a mine. If something then goes wrong, or the gold price falls, this can then potentially put them into financial difficulty. Equally, if the gold price soars, profits could fly and cash flow mushroom so paying down the debt adds to earnings growth via lower interest payments. 

•        Cost base. This will be a reflection of the factors above and investors need to focus on the all-in sustaining cost (AISC) of a miner or mine’s gold production per ounce, not the cash cost, especially as this takes into account the payment of interest on any debt. The lower the AISC the better as this offers more upside when gold prices rise and more downside protection if gold prices fall.

•        Valuation. During the gold price boom at the start of this decade, analysts would typically value explorers and developers at 0.5 times to 1.0 times net asset value (NAV) per share. They would value emerging producers at 1.0 times to 1.5 times NAV; and 1.5 times to 2.0 times NAV for mid and large-cap producers. Some analysts will use a blend of NAV and earnings multiples, using price/earnings (PE) and EV/EBITDA (enterprise value to earnings before interest taxes depreciation and amortisation) ratios, based on near-term earnings forecasts. However, a more scientific approach will focus on a detailed discounted cash flow (DCF) model that provides a net present value (NPV) of future cash flow streams, based on certain assumptions regarding the gold price and the miner’s cost base. The more mature gold producers may also pay a dividend so yield could be another valuation metric.

Funds

“If assessing individual gold miners sounds like hard work, then it is and there is no getting away from this. You do not necessarily have to be a geologist but you still need to assess where miners operate, their boardroom acumen, cost base and valuation before you take the plunge – and even then unexpected events such as weather, a change in local government of (mis)management of the assets could trip up the unwary investor.

“Investors who feel they do not have the time, skills or patience to do this research could therefore turn to a fund that specialises in precious metal miners. There are four types of collective investment available.

•        Passive or tracker funds. In this case, the fund will track the performance of an index or basket of gold miners and look to deliver that performance to the investor, minus its fees and running costs. There are four exchange-traded funds (ETFs) available to investors through the London Stock Exchange. Three – iShares Gold Producers ETF, L&G Gold Mining ETF and VanEck Vectors Gold Miners ETF – focus on large-cap gold miners, although they follow different indices. The iShares and L&G instruments follow the EMIX Global Mining Global Gold benchmark the VanEck product tracks the NYSE Arca Gold Miners index.

The five biggest holdings in each case are Barrick Gold, Newcrest Mining, Newmont Goldcorp, Franco-Nevada and Agnico Eagle, albeit in slightly differing proportions.

The fourth tracker, the VanEck Vectors Junior Gold Miners, provides access to a basket of mid-to-small cap miners, whose share prices are more likely to be volatile as they are more heavily geared to the gold price: a smaller movement in the metal will mean a lot more to them in terms of profit and cash flow than it will to the gold mining giants such as Barrick Gold. The five leading holdings in this tracker are Northern Star Resources, Evolution Mining, Kinross Gold, Gold Fields and Buenaventura Mining.

There is no fund manager or research process at work here, merely an algorithm that ensure the ETFs track the index and its members in the correct proportion and as closely as possible. Their annual ongoing charges range from 0.53% to 0.66%.

•        Active, open-ended funds. There are around half a dozen open-ended funds that specialise in researching and selecting precious metal miners to build a portfolio of equity holdings related to gold (and silver). BlackRock Gold and General is probably the best-known but other options include Investec Global Gold, Ruffer Gold Fund, Merian Gold & Silver Fund and Smith & Williamson Global Gold and Resources.

There is a fund manager to pay and a research effort to fund here, so the annual ongoing chares tend to be higher than the costs associated with ETFs, ranging from 0.71% to 1.76%. In return, the fund manager will save the investor time and effort and, in theory, outperformance of their index benchmark to justify the costs. 

•        Active, closed-ended funds. There is a select number of investment trusts which specialise in gold and precious metal miners, notably Golden Prospect Precious Metals and El Oro. Both trade at discounts to net asset value, and thus offer gearing into any sustained gold price rise (as that gap should close even as the underlying assets rise in value, providing a double-whammy) and El Oro offers a near-4% dividend yield, but neither is especially cheap to own, with ongoing charges including performance fees of 2.65% and 3.32%, according to data from the AIC.

•        Multi-asset funds. Some funds that can invest across a range of asset classes, as part of their mandate to the investors, could hold gold. One such example is Troy Trojan Fund, run by Sebastian Lyon, which currently holds a mix of income-generating equities, government bonds, gold and cash in its mission to protect investors’ wealth from all economic possibilities, inflation, stagflation or deflation.

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