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Welcome to the wobbly world of precious metals. For the three- and six-month periods ended Feb. 28, 2019, precious metals equity funds topped the category performance listings with average returns of 20.2% and 17.0%, respectively. Yet over the 5- and 10-year periods through February, this same group generated average annual compounded returns of just 1.4% and 1.8% respectively, ranking 43rd and 48th respectively among 55 fund categories. The Mackenzie Precious Metals Class Series A is a good example of this trend, posting a 6-month gain of 21% to Feb. 28.
After a decade in the doldrums, it’s a rather dramatic turnaround, even for precious metals, but is the upbeat news likely to continue? And what role might gold or other precious metals play in a properly diversified portfolio?
According to Benoit Gervais senior vice-president, investments at Mackenzie Investments in Toronto and portfolio manager of the Mackenzie Precious Metals Class Series A, much depends on economic developments going forward. But you also must understand the non-correlative nature of gold and other precious metals.
“Gold companies don’t grow like other companies,” says Gervais. “The bulk of their value added comes from the fact that they behave differently at different times, and the best performance comes in dire times. When real interest rates are negative, gold does grow in value.”
Strong economic growth, conversely, can have a damping effect on precious metals prices, and such has been largely the case since the financial crisis of 2008-09. “We saw a pause [in global economic growth] in 2018 due to interest rate hikes and trade wars, so in the last quarter of 2018 gold was up 20% rather than down 20%,” Gervais says, adding, “We’re not past the peak [of the current economic cycle]. We may pause in 2019 too, but if we do, it will be better in 2020.”
That doesn’t augur particularly well for gold over the short term but then, one never knows what the future will bring. There have been signs of a global slowdown lately, so that pause may become extended. “The reason for owning gold is as insurance if you don’t know what will happen,” says Gervais. “But you don’t buy insurance after a flood, you buy it before.
“We generally recommend 7% (of total assets) in precious metals as insurance. Now it’s gone up to 11% of assets [due to the recent uptick], so you need to reallocate,” Gervais suggests. “That’s how you use gold and precious metals. Our job is to make sure it’s not costing you too much.”
To that end, Gervais employs a process called sustainable free cash flow. “We have beat the benchmark GDX year after year because we have a different capital allocation model. One third is in seniors, one-third in juniors, and one third in explorers and producers, and we will underweight or overweight any of these depending on conditions.”
Gervais adds that cash flow is critical to any mining company. “Resource companies are all very capital-intensive, double the average of companies in the S&P 500,” he says. “When a mine is depleted, good companies will invest half their cash flow [in development of new resources]; if they’re too capital-intensive, they’ll need more than one half.
“Misallocation of capital is the biggest problem in this industry, so we look for companies that can reinvest wisely,” Gervais adds. “If they squander their cash flow, investors don’t see it in their pockets.”
As an example of companies to keep, Gervais cites Gold Fields Limited of Johannesburg, South Africa. “It has slowly diversified with a selection of assets with a long life, but not too long,” he says. “Most of its assets are now superior to those of top-tier companies. They’ve been able to reinvent themselves. Their sustainable free cash flow is high, and if they keep doing what they’ve done in past, it will be correctly reinvested or else paid to investors in the form of dividends.”
Olev Edur is an experienced financial and business journalist and a frequent contributor to the Fund Library.
Notes and Disclaimers
© 2019 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without written permission is prohibited.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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