Gold is up 10.5% this year and up 11.9% (1) since it bottomed in December 2013 following the US Federal Reserve’s (Fed) decision to begin tapering its quantitative easing (QE) program. Gold continues to rally despite the Fed announcing after its meeting in January that it will be reducing its QE program by another US$10 billion.
Porfolio managers Bradley George – Head of Commodities and Resources- and Scott Winship –Global Gold strategy-, at Investec Asset Management, answer some questions about the recent recovery of gold, and gold equities.
What has triggered gold’s rally?
We believe that the gold price has rallied because:
- Tapering has started and the announcement of the tapering program on 18 December 2013 was orchestrated to maintain a stable market environment.
- Exchange-traded fund (ETF) net outflows have stopped. There are now 56moz in global gold ETFs, and we are starting to see small net inflows.
- Physical buying continues to be strong out of China — now the world’s largest gold consumer.
- An article written by Simon Rabinovitch titled ‘China’s 500-tonne gold gap fuels talk of stockpiling’, which was published in the Financial Times on 11 February 2014 (2), also caused some interest.
- There is talk that India might relax some of the import duties that it implemented in 2013 (they currently stand at 15%) on the back of suggestions that the gold trade is still alive and well, albeit through back channels.
- US 10 year Treasury rates have moved lower to 2.7% from its starting point of 3% at the beginning of 2014. As illustrated by the chart below, the dislocation between real rates and the gold price is still extreme.
- US economic data in January and February has disappointed relative to expectations; non-farm payrolls, the ISM Manufacturing Index, retail sales and industrial production have all been poor. The obvious excuse is the weather — the US has been hit by snow storms and blizzards — so we will have to wait and see in the coming months if this was the case. With just about every analyst and forecaster expecting stellar US growth this year, better data must materialize.
- US dollar weakness has also helped the gold price.
- The precious metal sector has been a key underweight for long only funds and a short for hedge funds. Short covering is definitely occurring.
How are gold equities performing?
Gold equities are finally showing some beta to the upside. Gold equities this year are up 23%, which is just over 2x leverage, and more than the average 1.3-1.5x that we have seen recently. Coming from an undervalued position there was certainly ground to make up. Where we used to quote 30-40% upside for the equities, we now see 15-20%, so we believe there is still value to be had.
Fourth quarter results are currently being announced and the majority of companies are meeting forecasts and guiding positively. Production guidance is more or less in line with estimates, but importantly cost guidance is better. Currency tailwinds and general cutting of a fat cost base has helped return leverage to the bottom line. Capital discipline is much better than it once was.
Is now a good time to invest in gold?
These moves have been rapid, as the above factors have provided a good headwind for the metal. We have moved to $1335/oz in more or less a straight line, so there is an argument for a pause for reflection/correction. But technically gold has broken out (see the chart below) and has room to move. We believe that any retracement is a potential buying opportunity.
Historically gold has offered diversification and inflation hedge benefits, and we believe it still does. The economic recovery, in our view, is finely balanced and there are still significant debt issues and associated risk. In particular, we would point to stubbornly higher oil prices and believe that there will come a time when the world economy is viewed in a less favorable light. Furthermore, the valuation anomaly that exists in gold equities has seldom presented investors with such an opportunity for gold equity exposure. The brief rally we have seen barely registers on the chart below showing gold equities relative to gold bullion.
We believe gold companies that are disciplined with capital and focus on growing profitable production, not just ounces at any cost, will be rewarded in the long run. We continue to invest in these types of companies with approximately 30 high conviction holdings in the Investec Global Gold portfolios. The portfolio is further differentiated with its physically backed ETF positions in platinum and palladium. We believe that these metals not only provide diversification but have strong fundamentals as they are in deficit from a supply and demand perspective.