The following commentary is an excerpt from the Sprott Gold Equity Fund June 30, 2021, Semi-Annual Report.
July 17, 2021
Dear Fellow Shareholders,
We report to you on Sprott Gold Equity Fund’s (the “Fund”) semi-annual fiscal period ended June 30, 2021. For the six-month period, the Fund declined 9.09%. This compares to a decline of 1.25% for the PHLX Gold/Silver Sector Total Return Index (XXAU),1 the Fund’s prospectus benchmark, over the same period. Given the XXAU’s much larger-capitalization bias than the Fund, we are not surprised by the performance gap, which we discuss in more detail. A more apt performance comparison, the NYSE Arca Gold Miners Index (GDM)2 lost 5.39% during the six-month period; although the GDM is a better measure of medium-capitalization gold mining stocks, it (like XXAU) does not reflect the small-capitalization holdings held by the Fund.
During the six months ended June 30, 2021, gold prices posted an overall decline of 6.76%. Gold prices began the year at $1,898 per ounce and rose to a first-half high of $1,950 per ounce shortly afterward, supported by spiking COVID-19 cases, U.S. political uncertainty and talk of tougher lockdown restrictions as the U.S. dollar (DXY)3 weakened. However, after trending upward initially in January, gold bullion and gold-related investments sold off for the remainder of January and into February. Gold finished February at $1,734 per ounce, posting one of the worst months in four years for gold prices. Gold and gold equities had to share the limelight with other commodity markets as investors began anticipating a post-COVID global economic recovery, on the back of rising energy prices, the U.S. government spending bolstering the reflation trade and a rally in broader equity markets.
During March, gold prices continued to come under pressure with the roll-out of COVID vaccines in the U.S. encouraging market optimism that was reflected in rising U.S. 10-Year Treasury yields and a stronger U.S. dollar. Towards the end of the first quarter, the accumulation of gold mining equities was apparent in the market even as gold prices fell, with notable rebounds in precious metals equities after gold prices corrected. After gold prices traded to a low for the period in early March at $1,684 per ounce, they found double-bottom support at around $1,685 per ounce during late March.
Gold prices made a steady move upward during April and May as yields on U.S. 10-Year Treasuries, which were rising since the beginning of the year, peaked in late March and then edged downward, a move that coincided with U.S. dollar weakness during those months. Gold ETF sales, which have been consistent since the start of the year, eased and began to reverse at the end of April. Investors began to acknowledge more broadly that a robust U.S. economic recovery was likely to incorporate inflationary pressures. This sentiment helped push the gold price back above $1,800 in early May and to close the month at $1,907.
The U.S. dollar regained some strength in June and gold initially pulled back from the $1,900 per ounce level. Gold prices came under pressure during June as markets began to anticipate that the U.S. Federal Reserve may one day tighten monetary policy. Markets then decided that this day may be further out, given a series of new COVID variants and waves of infections spreading worldwide and slowing the global economic recovery. Bond markets took note with U.S. 10-Year Treasury yields sliding back to levels seen earlier in the year, concluding that a move to a higher interest rate environment is not conducive to a solid economic recovery, especially if COVID persists. Gold took a cue from that and put in another double-bottom at around $1,760 per ounce in late June, higher than the double-bottom support seen during late March, and suggests from a technical perspective, mid-term support for gold prices has been established.
Gold mining equities followed a slightly different but more volatile pattern than the gold bullion price during April and May, with a relatively steady rise during those months. Even though June’s pullback in gold stocks in the second half of the month partially offset the April/May recovery, gold stocks ended with a positive move for the second quarter of 2021. As markets head into the second half of the year, the recent positive performance and stronger market activity have begun to offset the January and February correction.
Despite the volatile first half for precious metals investors, a comparison to 2020 reveals that much ground has been gained. The gold price finished the first half of this year at $1,770 per ounce and averaged $1,806 during the first six months. That compares to the first half of the 2020 calendar year when gold finished at $1,781 per ounce and averaged $1,648. Silver often trades in sync with gold and is considered a monetary metal but tends to be more sensitive to manufacturing activity as it is also a production input. Silver prices landed at $26.13 per ounce as of June 30, 2021, and averaged $26.47 for the first half. This compares to a finish of $18.21 per ounce and an average of $16.64 for the same calendar period last year.
Here we offer a deeper analysis of the Fund’s performance relative to its prospectus benchmark. The Sprott Gold Equity Fund’s allocation process has emphasized greater exposure to small- and mid-capitalization precious metals mining stocks because their valuations offer greater long-term appreciation potential compared to the PHLX Gold/Silver Sector Total Return Index (XXAU). The XXAU is a capital-weighted index which means that the larger companies in the Index account for the greater percentage of the Index’s value and performance. Unlike the Fund, the XXAU is heavily weighted to larger precious metals producers, and in particular, to Freeport-McMoRan Inc., which represents one of the largest components of the XXAU and was not a holding of the Fund during the six months. While Freeport produces gold as a byproduct of copper production, it is primarily valued as a copper mining company by market participants. Freeport’s performance can have a significant impact on the performance of XXAU. This was certainly the case in the first half of 2021, as copper prices surged during February and May (reaching an all-time high in Q2) while gold corrected during the first half of 2021. Copper prices gained a whopping 23.92% from January 1 to June 30, 2021. Another major difference between the Fund and the XXAU benchmark is that physical gold is not included in the Index; the decline in gold prices of 6.76%, as mentioned earlier, was certainly a drag on the Fund’s results in the first half of the year.
The Fund’s largest position as of June 30, 2021, was physical gold (measuring 74,526 gross ounces) which is vaulted in a secure location outside the financial system and audited regularly. This gold bullion position represented 12.10% of the Fund’s value as of June 30, 2021. The exposure to physical gold reduces the Fund’s volatility and offsets the more volatile moves in gold and silver mining equities. Precious metals equity valuations are greatly influenced by moves in gold and silver prices. Precious metals equities accounted for 85.91% of the Fund’s holdings5 as of June 30, 2021, and included 69 securities, with about 76.90% allocated to the gold industry and approximately 12.59% in the silver and silver mining industries.
The precious metals stocks that contributed the most to the Fund’s performance during the period included Corvus Gold, Inc., Osisko Gold Royalties Ltd, Sibanye-Stillwater Ltd., Newmont Corporation, and Gatos Silver, Inc. (representing 5.40%, 3.97% 3.45%, 2.98% and 1.45%, respectively, of the Fund’s net assets5 as of June 30, 2021). Corvus Gold, Inc. has had drilling success at its Motherlode and North Bullfrog properties in southern Nevada. This has recently resulted in a proposal by AngloGold Ashanti Ltd., the largest Corvus Gold, Inc. shareholder, to buy the entire company. The Fund is the second-largest owner, holding about 17% of Corvus Gold, Inc. shares and would receive cash under the AngloGold Ashanti Ltd. proposal. Sibanye-Stillwater Ltd. has demonstrated its cash flow generating ability from its various precious metals mines, which produce platinum group metals in addition to gold, while its exploration projects include copper, gold and platinum group metals projects. The company’s balance sheet is in a net cash position relative to its debt, providing flexibility to develop additional assets and return shareholder value. After Gatos Silver, Inc. self-financed the build of its mine and initiated metal production, its successful IPO (initial public offering) allowed it to reduce debt quickly and renew regional exploration around its Los Gatos Joint Venture, where numerous exploration targets have not been tested since the company began its mine building project several years ago. Osisko Gold Royalties Ltd. has re-rated and received a better valuation after some restructuring and the market’s recognition of its compelling royalty and streaming portfolio. Newmont Corporation continues to establish itself as a reliable environmental, sustainability and governance (ESG) gold mining company. In addition to its growing ESG recognition, Newmont Corporation has added considerable balance sheet strength with its robust cash flows.
Positions that negatively impacted the Fund’s performance during the period included: the physical gold position, SilverCrest Metals Inc., International Tower Hill Mines Ltd., Torex Gold Resources Inc, and Jaguar Mining Inc. (representing 12.10%, 3.26%, 2.59%, 2.57% and 2.38%, respectively, of the Fund’s net assets5 as of June 30, 2021). Jaguar Mining Inc. and SilverCrest Metals Inc. had been outperformers over the past year and a half; while the physical gold bullion position corrected with the gold prices during the period. Torex Gold Resources Inc. is initiating mine construction while International Tower Hill Mines Ltd. continues to work on improving plans and design for processing ore at its project in Alaska in preparation for making a construction decision to build its mine.
Despite a challenging first half for the precious metals complex, we believe the investment rationale for precious metals exposure remains strong. Gold bullion and gold mining stocks are compelling buys. The vast majority of producing miners are generating free cash flow. Current strong earnings are geared to advance at a steep slope should our positive expectation for future gold prices prevail. Valuations, both relative and absolute, are the most attractive they have been in two decades. Although gold experienced a sell-off in June 2021, this was mostly driven by algorithmic, robotic macro funds. The accumulation and investment in physical gold continue. On June 18, 2021, investors bought $630 million of 100% gold-backed GLD shares (SPDR Gold Shares ETF),4 the largest one-day inflow since January 15, 2021. Central banks bought $6.3 billion of gold during the second quarter.
We remain skeptical about the health of this post-COVID global economic recovery. The current level of economic activity is highly dependent on continued fiscal and monetary stimulus. As COVID pandemic-related support begins to decline, disappointing housing, retail sales and employment data show the economy is losing steam. There is ample reason to think that a slowdown could become a downturn in the absence of renewed fiscal support. Without continued stimulus amid rising food and energy costs, consumer spending could come under pressure. Our view is that a significant slowdown lies ahead and that inflation is likely here to stay.
Faith in the Fed’s omniscience and ability to control inflation is convenient to the investment consensus because it underpins the current extraordinary overvaluation of financial assets. Let’s face it, despite pious subservience to the goals of full employment and price stability, the Fed’s real mandate is to keep financial markets from coming unglued. The relationship between overvalued financial assets and belief in an all-knowing Fed is symbiotic. Loss of that faith for heavily sedated markets would lead to losses of trillions of dollars in the world of financial assets. That very real possibility is sufficient rationale for investment in gold and the expectation of much higher gold prices.
With best wishes,
John C. Hathaway
Senior Portfolio Manager
Douglas B. Groh
Senior Portfolio Manager
1 The PHLX Gold/Silver Sector Total Return Index (XXAU) is a capitalization-weighted index composed of companies involved in the gold or silver mining industry.
2 The NYSE Arca Gold Miners Index (GDM) is a modified market capitalization-weighted index comprised of publicly traded companies primarily involved in mining gold and silver in locations worldwide.
3 The U.S. Dollar Index (USDX, DXY, DX) is an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners’ currencies.
4 SPDR® Gold Shares (GLD) is the largest physically backed gold exchange traded fund (ETF) in the world.
5 Net assets exclude cash equivalents, other assets & receivables.
The views expressed above reflect those of John Hathaway and Doug Groh as of the date stated above and do not necessarily represent the views of Sprott Asset Management USA, Inc. or any other person in the Sprott organization. Any such views are subject to change at any time based upon market or other conditions and Sprott disclaims any responsibility to update such views. These views may not be relied on as investment advice and, because investment decisions for the Sprott Focus Trust are based on numerous factors, may not be relied on as an indication of trading intent on behalf of the Sprott Gold Equity Fund.
To learn more about Sprott Gold Equity Fund, please telephone a Sprott representative at 888.622.1813 or email email@example.com.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectus which should be considered carefully before investing. Click here to obtain the prospectus or call 888.622.1813.
Past performance is not a guarantee of future results. All data is in U.S. dollars unless otherwise noted. Sprott Gold Equity Fund invests in gold and other precious metals, which involves additional and special risks, such as the possibility for substantial price fluctuations over a short period of time; the market for gold/precious metals is relatively limited; the sources of gold/precious metals are concentrated in countries that have the potential for instability; and the market for gold/precious metals is unregulated. The Fund may also invest in foreign securities, which are subject to special risks including: differences in accounting methods; the value of foreign currencies may decline relative to the U.S. dollar; a foreign government may expropriate the Fund’s assets; and political, social or economic instability in a foreign country in which the Fund invests may cause the value of the Fund’s investments to decline. The Fund is non-diversified, meaning it may concentrate its assets in fewer individual holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility than a diversified fund.
NOT FDIC INSURED • MAY LOSE VALUE • NOT BANK GUARANTEED
Sprott Asset Management LP is the investment adviser to the Fund. The information contained herein does not constitute an offer or solicitation by anyone in the United States or in any other jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation. Sprott Global Resource Investments Ltd. is the Fund’s distributor.
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