The jaws of a golden opportunity

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Articles by Duncan

Duncan MacInnes

Fund Manager

12 October 2018

It might not be obvious but the axiom ‘a bird in the hand is worth two in the bush’ is a wonderful demonstration of two human behavioural biases.

The first is time preference – a desire to receive gratification now rather than later; the second is prospect theory – the willingness to pay a high price to remove uncertainty.

But what if the pay off alters? Today, an investor can buy a proven ounce in the ground for less than $400, compared to $1,200 in their hand. An ounce of gold in hand might be worth three or four in the bush!

The investment case for gold is eternal: it is nobody’s liability, an unimpeachable, uncorrelated safe haven and store of wealth. It is said that over hundreds of years an ounce of gold has always been able to buy a Savile Row suit, at current prices you’d be lucky to get the trousers! Post crisis we can add that it also offers an insurance policy against the possible consequences of $22 trillion of central bank balance sheet debauchment.

Much has been written about gold’s lacklustre performance in recent times, but if you were holding bullion in Ankara or Buenos Aires this year you would be sitting on gains of 50%, when the world around you has been tumbling down. It has done exactly what is required as a hedge against monetary disorder.

It is in this protective role that the young pretenders in the crypto-currency world have failed. We expect that the bursting of the crypto-bubble should act as a reminder of gold’s enduring qualities.

In today’s technology giddy world gold is the unfashionably ‘barbarous relic’. The headwinds are compounded by a rising dollar and interest rates raising the opportunity cost of owning the metal. But the US dollar has travelled a long way, rising 20% since 2014 and President Trump seems likely to lean against further strength with his spending plans and focus on the terms of trade. At the margin the headwinds are becoming less negative.

The case for gold equities, a supercharged play on the commodity, lies in the jaws of opportunity which have opened up following the stark underperformance year to date. After this divergence, a variety of valuation metrics based on cash flow or asset value put the sector near all-time lows.

Over the last 15 years the gold price is up 110% and yet the mining equities (HUI index) have lost around 30%. It is hard to find a poorer performing industry with worse capital allocation. So all-encompassing is the pessimism that Vanguard have just restructured and rebranded their ‘Precious Metals Fund’ to a ‘Capital Cycle Fund’! We estimate this has forced the liquidation of almost $2 billion of gold equities into a weak market.

In summary gold equities are cheap, unloved, defensive and ripe for the sort of rationalisation we have seen in the oil and gas sector following the lean years of 2015-2017. We may be seeing the first signs of this with the Randgold Resources/Barrick Gold merger. At Ruffer we are excited about the outlook for gold mining stocks where we see two ways to win: macro events could develop favourably for gold or the market can reappraise the value of the equities. For these reasons we have been switching gold bullion into the gold mining equities and increasing our overall exposure in September.

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The jaws of a golden opportunity