Investors should be enthusiastic about gold and gold-mining equities, says Doug Groh, portfolio manager and senior research analyst at Tocqueville Asset Management in New York.
He revealed his predictions for the sector at the IMCA New York Consultants Conference, while also discussing how to help clients approach gold investing.
He says, “[Investors] recognize the sector has merit since monetary policies are debasing currencies. Gold provides a nice alternative to these policies’ [effects].”
However, gold mining stocks that are leveraged to gold prices haven’t performed very well over the last couple years; this is one reason why investors have been stalling this year.
But Groh says to gain perspective by “stepping back and realizing that gold stocks have performed well in the last four years.” While they were down 50% or more in the last two years, he reminds us they were up at least 75%-to-100% in 2009 and 2010.
Thus, “If you look at net value, there’s still a positive trend, though the last two years haven’t reflected this. In fact, gold prices—which drive mining equities—have also done well.”
The sector performed well because there were high expectations for gold based on positive price outlooks. Not to mention, mining companies represented growth potential through the expansion of their projects.
Due to this, gold bugs assigned high values to the stocks. But production growth hasn’t come through as quickly and profitably as expected.
“That’s been a function of higher operating costs, which have been caused by a global mining boom,” says Groh. “Demand for labour, inputs, and equipment have been higher than expected.”
He adds, “Capital expenditures for these growth projects have also risen significantly. Investors have been dissatisfied with the lack of cash-flow generation of the mining companies and their growth plans.”
A change in how companies are operating could remedy this problem, says Groh. Lately, he finds, a number of management teams are being replaced—the top five companies’ teams have recently stepped down.
Additionally, companies need to improve cost management and capital allocation and spending.
He predicts investors will then see more favourable operating profits. However, this won’t be enough to create a buzz around stocks. For this to occur, prices would have to be “on their way to $1,900 an ounce later this year for investors to be feel comfortable with the risks they perceive in the sector.”
And for this bump to occur, Groh says macro concerns would have to ease. Investors are worrying about currency values, monetary policies, negative real interest rates and the U.S. debt ceiling.
“There’s been more discussion about currency wars,” he adds.
On the plus side, central bank buying has been key to gold market growth and it should continue. Banks around the world bought 530 tonnes of gold over 2012, a 17% jump over 2011.
Interestingly, Groh finds “gold equities right now are valuing [the metal] as if it was at $1,400 an ounce right now. So, the equities are valuing gold at the cost of production, while prices at $1,650 an ounce [would be] more reflective of the demand in the marketplace.”
He adds, “While stocks are taking downsides into account, they aren’t representing the upside and reality of where prices are currently; the valuation is at historical low values.”
If your clients are interested in gold, Groh suggests starting the conversation with a macro discussion about interest rates, which have pushed many economies to implement simulative policies, such as in Japan and Europe.
He says this causes currencies debasement, with gold able to provide an alternative investment.
In fact, he calls gold a “store of value” rather than a “safe haven” investment; though many refer to gold as safe, it can actually be quite volatile.
“A safe haven assumes you’re not exposed to risk and is more of a temporary concept,” says Groh. Instead, people should consider gold more as a long-term investment.
Investors should have 5%-to-10% of their portfolios invested in gold, whether that’s through gold bullion or ETFs, or through gold stocks.
Groh adds the sector is very dynamic. He finds active management best captures opportunity and value if clients are open to the process.