Gold hit a new record on the 27 July, trading well through the 2011 top of $1,921.17/oz. This leads to the questions: Is it still a buy here? Have I missed it? 
Our belief is gold has further to run. However, we have greater conviction in the small to mid-cap miners in the sector continuing to outperform, as they close their valuation discount with their larger peers. There are two primary drivers to this:
- Firstly, capital has flowed away from the small-cap miners for a number of years, moving to gold-focused passive equity ETFs, which had widened the premium for the larger and more liquid miners. Whilst there has been some outperformance at the junior end of the market, there has still only been a partial reversal of this multi-year trend.
- Secondly, a key driver is the lack of exploration spend by the large-cap miners which has led to declining reserves and a lack of growth options. The current strong gold price is leading to strong earnings for those large-cap miners, who may pay some out in dividends but will want to at least offset declining reserves, if not try and return to growth. This will likely lead to a pick-up in M&A, which further aids closing this valuation gap. The developers in the sector have performed especially well, in part due to low capital cost pressures reducing the risk of cost overruns. But, also, the markets focus on producers, enabling a meaningful rerating as they transition toward producers.
As the managers of a precious metal fund we are, unsurprisingly, bullish on the underlying metal. The primary driver of the gold price is real yields, which is the return received from interest rates minus inflation. When real returns are low, gold has historically performed strongly. The fallout from Covid-19 has led to coordinated rate cuts globally, with an economic fallout that is yet to be fully understood. We see no evidence to suggest any risk of an increasing rate cycle in the near term. Typically, there are two sources of inflation – either demand-led or supply-led. Demand is generally soft, but pent up demand may surprise, whilst supply is where the biggest impact may be seen, as the huge deflationary pressures experienced from China Inc. over the last two decades may reverse as they find themselves increasingly politically and economically alienated from the global stage.
Source: Bloomberg. Gold in US dollars vs US 10yr Treasury Inflation Linked bond (Real Yields - Inverted)
The above chart is the driver of the largest physically backed ETF funds having added over 28Moz (millions of ounces) this year to take aggregate holdings to 106Moz. Conversely, jewellery demand has been weak, down 46 per cent in H1 year-on-year, as gold is now far more expensive in the major demand economies such as India, China and Turkey, particularly in weakened local currency terms. This is a reversal of the flows for gold from West to East witnessed in the previous decade, as financial investors have become the primary driver.
Silver has begun to catch up with gold. The gold/silver ratio, which reached an all-time-high of 124x in March, moved back to 80x as at 27 July, which is still at the upper end of typical trading ranges over the last 50 years. The Golden Prospect Precious Metals fund we manage holds 25 per cent in silver as we believe silver can continue to catch up with gold’s rise, as a relatively cheaper alternative safe haven. Furthermore, approximately 5 per cent of silver demand is related to recovering industrial use, primarily electronics, which stands to be a beneficiary of the 5G build-out and general reopening of the global economy. In addition, by virtue of being used in photovoltaic solar cells and as a catalyst to produce hydrogen for fuel cells, silver may also be a beneficiary of “green” focused fiscal stimulus proposed by the European Central Bank.
We urge investors to conduct sufficient due diligence on projects, but perhaps more importantly to know and trust the management teams behind the companies. This is not straightforward and undoubtedly a gold bull market will bring more opportunist management teams back to the sector.
Rob Crayfourd and Keith Watson, co-Portfolio Managers of the Golden Prospect Precious Metals fund. The views expressed above are their own and should not be taken as investment advice.