Barron’s had a solid write-up on gold over the weekend. “Gold has been a traditional hedge against financial and economic crises, playing that role during the 2008-09 meltdown. Gold rallied 17% from the collapse of Lehman Brothers on Sept. 15, 2008, until the stock market bottomed on March 9, 2009—a period during which the S&P 500 fell more than 40%,” explains Andrew Bary.
But what is worth noting is the recent change in the mandate of the Vanguard Precious Metals and Mining fund away from precious-metal mining at perhaps the worst time. This is yet another example of how mutual funds can zig when you want them to zag. And it’s exactly why mutual funds may no longer work for your portfolio.
In July, Vanguard announced that the $1.8 billion Vanguard Precious Metals & Mining fund (VGPMX), the largest gold-oriented U.S. mutual fund, would be renamed Vanguard Global Capital Cycles later this month and that its precious-metal mining exposure would be reduced in favor of other commodity-related industries and global infrastructure, such as telecommunications. Gold and precious-metals mining stocks will make up at least 25% of the fund.
Gold bulls see the action as a sign of capitulation. Vanguard’s move in 2001 to take the “gold” out of the fund name and broaden its mandate coincided with a bottom at about $255 an ounce.
Some closed-end funds own physical gold. For example, Sprott Gold & Silver Trust(CEF), holds roughly two-thirds of its assets in gold and a third in silver. That longstanding fund, formerly known as theCentral Fund of Canada,trades around $11.75, a 4% discount to its net asset value. Toronto-based Sprott also runs the Sprott Physical Gold Trust (PHYS). Both funds, unlike the SPDR ETF, allow holders to take physical delivery of the yellow metal. This appeals to survivalists, who populate the ranks of gold bugs.
Gold-mining stocks, like other natural-resource producers, can offer a leveraged play on the commodity. When gold prices rise, mining earnings typically increase by a greater percentage. Take a mining company with an all-in cost of $1,000 per ounce. If gold rises 25%, to $1,500, profits could more than double, with margins going from $200 to $500 an ounce.
Now however, gold-mining shares are even more depressed than the metal itself because financial leverage cuts both ways. The largest gold-mining ETF, the $8 billion VanEck Vectors Gold Miners(GDX), is down 19% this year, to about $19, after hitting a 52-week low recently. Its largest holdings include industry leaders Newmont Mining(NEM), Barrick Gold, Newcrest Mining(NCMGY), Goldcorp(GG), and Franco-Nevada.
Mining companies have many challenges, to be sure. Countries in Africa and elsewhere are trying to gain greater control of their resources, and projects can face environmental opposition. Major finds are rare. But the mining companies are showing greater capital discipline and now trade at historically low levels of cash flow.
Reflecting the frustration with the miners’ performance, a group including billionaire hedge fund manager John Paulson announced on Friday the formation of a coalition of 16 investment managers called the Shareholders’ Gold Council to publish research and “promote best practices” in the industry.
Newmont is the industry leader with a $17 billion market value, a strong balance sheet with under $1 billion of net debt, and a dividend yield of almost 2%. The only gold stock in the S&P 500, it trades for $31, or 24 times projected 2018 earnings of $1.30 a share. That’s not a cheap multiple, but Newmont and other big miners rarely trade at low price/earnings ratios and often are evaluated on their “option” value, meaning they offer a long-term play on potentially higher gold prices.
“Newmont has been one of the most successful majors in fixing its balance sheet and rebuilding its production,” says John Bridges, a mining analyst with JPMorgan. He has an Overweight rating on the stock, with a $40 price target. Newmont’s production is seen holding steady at about five million ounces annually over the next five years.
Newmont’s gold output generally comes from relatively safe locations, with North America and Australia accounting for about 70% of it. Bridges says that the U.S. is now viewed as one of the best places to mine gold, thanks to the cut in the corporate tax rate and other tax breaks. So, Newmont and other miners are expanding domestically.
Barrick Gold has been a turnaround story. In recent years, the company has cut debt by nearly $10 billion, to $5 billion, through asset sales and internally generated cash flow. The shares, at about $10.50, trade for 19 times projected 2018 earnings of 55 cents a share and yield just over 1%.
The driving force at Barrick has been its chairman, John Thornton, a former top Goldman Sachs executive. Reflecting his Goldman roots, he has sought to bring what he calls a “partnership culture” to Barrick. He wants the company to focus on increasing shareholder returns and not fall into a common industry trap of chasing “ounces,” or production, without regard to costs.
“Barrick is a relatively low-cost operator, with people at the top who are focused on profitable capital allocation, rather than growth for growth’s sake,” says Trauner, the GoodHaven portfolio manager, which holds Barrick. He argues that at its current share price, Barrick offers a nearly free option on higher gold prices. In a better environment, the stock could be a lot higher. Barrick earned more than $4 a share and traded at $50 in 2011 when gold peaked at $1,900 an ounce.
The knock on Barrick is that Thornton’s focus on returns has gone too far and that the miner’s annual gold production, which is expected to decline to about 4.75 million ounces this year from 5.3 million ounces in 2017, could drop further. The company has run into political problems with mines in Argentina and Tanzania.
“Barrick fixed the balance sheet and stabilized the business. Now, it needs to show that it can grow in a sensible way,” Trauner says. Some think that Barrick could become a takeover target for a Chinese buyer. Thornton has cultivated a strong relationship with the Chinese, with Shandong Gold buying a half-interest in a large South American mine from Barrick.
Franco-Nevada has been the top-performing major gold-mining stock since its inception in late 2007, returning 16% annually, handily topping the metal, the VanEck ETF, and the S&P 500 index.
The company owes its success to an attractive portfolio of assets and a capital-light business model that give investors effective exposure to the equivalent of nearly 500,000 ounces of annual gold production. Franco-Nevada doesn’t own or operate mines. Instead, it makes investments in new and existing gold, precious metals, and energy assets in return for revenue streams from ongoing production. Franco-Nevada’s operating margins of 70% to 80% are double that of the typical miner.
Lassonde, the Franco-Nevada chairman, calls it “the best business model on the planet” because of its exposure to a growing portfolio of what he considers to be appealing mining properties. The company has just 31 employees.
Investors have recognized Franco-Nevada’s strengths: The company, whose shares trade around $65, fetches 53 times estimated 2018 earnings. The stock yields 1.5%.
Bridges, the JPMorgan analyst, calls Franco-Nevada the “Mercedes” of the gold-mining industry because the company has been able to protect investors in down gold markets while giving them upside in a rising market. He carries a Neutral rating on the shares with an $85 price target. With the stock down from a peak of $85 in late 2017, investors can get the Mercedes at a discount.
U.S. stocks are at record levels exactly at a time when global stress—trade tensions, populist nationalism, and the like—appears to be growing. This may be an opportune moment for investors to shift at least a portion of their portfolios to gold: both the metal and depressed mining shares.
To flip Buffett’s phrase, gold may do more than just look back at you in the coming years.
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