“If you wear your hat as a value investor or as a contrarian, you have to be interested in gold stocks.” - John Hathaway
John Hathaway, Senior Portfolio Manager, joins host Ed Coyne for an informative discussion on gold equities. They cover the effects of interest rates on gold, how gold miners are performing in today’s climate, the key differences between gold mining equities and the S&P 500 Index and Sprott Gold Team’s process for evaluating gold stocks.
Ed Coyne: Hi, welcome to Season 1, Episode #2 of Sprott Gold Talk. I am your host, Ed Coyne, Senior Managing Director at Sprott Asset Management. Today, I've asked John Hathaway, Managing Director and Senior Portfolio Manager of Sprott Gold Equity Fund, to join me to talk about another level of gold. In Episode #1, we talked about the physical gold market and how to allocate to that space, and how to make physical gold a productive asset.
Today, with John Hathaway, we will take a deeper dive into the gold equity story, particularly given the most recent sell-off we've seen over the last month. Let's start with first the physical market. We've had a bit of a sell-off here in the last couple of months. John, what has been going on in the physical gold market over the last four to six months?
John Hathaway: It's mainly higher interest rates. People are very concerned that the 10 year [U.S. Treasury bond], which was close to 1.0% six months ago, is now closer to 1.5%. I think there's a lot of algorithmic trading that positions gold as the other side of that trade. Short bonds, short gold, bullish on the cyclical side of the economy; I think this is what is really going on.
Ed Coyne: How is this affecting gold miners? Are you growing bearish on the miners, or are you opportunistic about the miners? What's happening with the miners given that gold's cooling here, at least in the short term?
John Hathaway: The miners are very profitable, even though the gold price has retreated some $300 from the peak level it reached at the beginning of August of last year. Gold mining companies are generating significant cash flow. Their earnings comparisons year-over-year are going to be very positive, mainly because the average gold price if we assume the worst of it is $1,700, will still be positive on a year-over-year basis. Plus, many miners were shut down for varying periods of duration in 2020 because of the COVID-19 pandemic.
As we come out of the pandemic, which is happening now, you'll see a more normal operation level. I think the earnings momentum is there. In addition to that, the macro outlook for the gold price is very positive, which we can address. I believe that gold stocks right now are compelling from a risk-reward point of view.
Ed Coyne: Let's touch on that briefly. Many investors, rightly or wrongly, think about returns on a quarter-to-quarter basis. As we've seen over multiple market cycles, gold's is best viewed as a decade-to-decade type of allocation. Clearly, the physical market is something you want to own as a core allocation, as a way to diversify your portfolio. And there are times when you want to consider gold equities, and at Sprott, we believe that right now is one of those times. In your view, what should an investor be looking for in the coming quarters as they look to allocate capital to the gold miners?
John Hathaway: The first thing is that gold is out of favor and gold mining stocks are even more out of favor. I've been investing as a gold specialist since 1998. I have never seen the values as compelling as they are right now. If you wear your hat as a value investor or as a contrarian, you have to be interested in these stocks, even if you don't take a particularly bullish macro view of the gold price, which I think is another discussion.
We are in a world of overvalued securities, both bonds and stocks. I wrote a paper at the beginning of this year showing that the valuation of the S&P 500 was in the 100 percentile of all historical experience [see One of the Greatest Bubbles in History]. And this can go on for a bit. But it would be hard not to say that the investment consensus is priced for perfection and that we'll probably get less than perfection. Gold mining stocks, which have had a correction going back to last August, have come down to valuation levels where if the broader stock market were to sell off, which I think is a reasonable bet, you would probably have much less risk in gold mining stocks.
Again, if the stock market were to sell off, it seems that it would be bullish for gold because investors would look for defensive strategies to protect capital. Of course, both gold bullion and gold mining stocks, by extension, are part of that defensive strategy. Let's not forget that the group has a current yield higher than the S&P 500 Index [above 1.5% as of 12/31/2020]. And valuations are about 50% of what you can get in the S&P 500 if you look at several different valuation metrics. So you have value going for you, you have contrary thinking going for you, and you have a very good possibility that the gold price correction, if it hasn't already, will very soon run its course. We believe that we could see another leg up in the gold price that takes us to new highs, which I think would inject a tremendous amount of buying into this sector.
Ed Coyne: The macro narrative for both physical gold and the gold equities is stronger than you've probably seen in your career. Interestingly, I always have to remind people that gold miners are stocks also. They have earnings, they have management and they have costs. Let's take a closer look at the underlying companies, not giving individual company names, but thinking about them as a business buyer. If you are going to buy one mine over another mine, what are some of the critical items or key metrics you look at as a portfolio manager when you're making an investment decision?
John Hathaway: We start with an assessment of management. There are good managements, there are average managements and there are less than average managements. First and foremost, we take into account the capability of management. We also consider the quality of the assets, the mining assets – and several things go into that -- and then we look at valuation. These three things are critical: management, asset quality and valuation. We then put our heads together within the Sprott Gold Team and discuss these ideas daily. It's an ongoing process of evaluating all of those factors. We recently, last week, had literally up to 100 company meetings at the BMO Global Metals & Mining Conference, which is an annual event. This year it was virtual, and I had 35 or so meetings. Some of the analysts had up to 60 meetings at the five-day conference. We used this event to refresh our understanding of the holdings we have and think about possible new additions to our managed portfolios. This is an ongoing process, but it's the quality of management, the quality of the assets and valuation, all three.
Ed Coyne: It looks like we have some wind in our sails from a global narrative, effectively a hangover effect from the COVID-19 pandemic. It appears to me that not only does the physical gold market make sense in diversifying a portfolio, but today an opportunistic allocation to gold equities should be considered when looking to potentially add some total return to investment portfolios.
Thank you, John. We encourage our listeners to visit us at Sprott.com and reach out to us for any questions or comments. Thank you for listening. I'm Ed Coyne, Senior Managing Director at Sprott Asset Management.
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