Time to go for the gold?

Outlook brightens for gold ETFs and mining companies

Some investors were disappointed by the performance of gold last year. While it has traditionally been regarded as a hedge against rising inflation, the price of gold in U.S. dollar terms hardly moved during 2022, while inflation more than doubled. However, compared with the declines in the major stock indexes, as well as the more than 10% drop in the bond market, gold in fact performed its traditional role of being a diversifier within a portfolio.

This means gold is not correlated with either stocks or bonds. In other currencies, such as the euro, sterling, or especially the Japanese yen, gold in fact was up between 5% and 15%, as the early aggressive action by the Federal Reserve meant the U.S. dollar appreciated to its highest level in over a decade.

In fact, gold hit an all-time over $2,000 per oz. (prices in U.S. dollars) after the Russian invasion of Ukraine, before subsequently selling off by $350 an oz. (18%) to bottom out at $1,650 an oz. in October. Gold once again neared $2,000 per ounce on March 20, but has since backed off.

Should gold break through these levels, there is no resistance on the charts before the next round number of $2,200 or more likely $2,500 an oz. That would represent a 25% rise in the price.

Gold has managed to hold its value despite large outflows from the major gold ETFs such as SPDR Gold Shares ETF (NYSE: GLD), and has been supported by increased buying by many overseas central banks, such as China, India, and Russia. Should investor sentiment in North America become more favourable towards gold and precious metals, then given fewer major discoveries over the past decade and the resulting small annual increase in gold output, the extra demand could easily lead to rising prices.

Investing in gold miners

Holding physical gold or gold ETFs are two ways to invest directly in gold. Another way to gain exposure to gold is by investing in shares of gold mining companies, although there are always operational problems of running mines. These include disappointing grades, rising costs for fuel, equipment and labour, and political and environmental disputes.

Mark Twain famously defined a mine as “a hole in the ground with a liar on top.” And there is some truth to that, especially in the junior mining sector, where over-optimistic and promotional management has often been a defining feature of the industry.

Nevertheless, professionally run gold mines offer a leveraged play on the price of the precious metal, as every dollar increase in the price of bullion drops straight through to the company’s bottom line, as costs remain constant. During the 1970s bull market in gold, the price rose from the artificially restrained level of $35 an ounce to $850 in 1980. That was a 24-times increase, and gold mining shares rose even more.

During the last bull market between 2000 and 2011, gold rose from $250 an ounce to $1,800, a seven-times increase. The share prices of gold miners such as Agnico Eagle and Yamana rose more than 10 times.

More recently, gold mining companies have cleaned up balance sheets by reducing debt, avoiding dilutive acquisitions at extended prices. They are returning cash flow to shareholders by paying dividends linked to the gold and silver price. As a result, gold miners are now much less risky and volatile investments.

The four largest gold miners by market capitalization are Newmont Corp. (NYSE: NEM), Barrick Gold Corp. (TSX: ABX), Franco-Nevada Corp. (TSX: FNV), and Agnico Eagle Mines Ltd. (TSX: AEM).

Franco-Nevada has been by far the best performing precious metals stock over the past decade, up more than five times while the price of gold was unchanged. It uses a royalty and streaming model, where it receives between 0.5% to 3% of the revenues of a mine in exchange for providing finance. This is the lowest-risk way of gaining exposure. Franco-Nevada has no exposure to rising costs, supply disruptions, or environmental liabilities. Its wide geographical diversity and exposure to different metals reduces vulnerability to a single project.

Conservative asset managers, such as the Swiss private banks, which focused on capital preservation and inflation protection, always used to recommend having between 5% and 10% of an overall portfolio in gold and precious metals, whether in the metal itself or in mining stocks. The arrival of gold ETFs gives owners an exposure to a tenth of an ounce of gold. This has removed one of the major disadvantages of investing in physical bullion or coins, namely the logistical difficulties of owning, storing, and insuring the metal. Now, for the cost of a brokerage order, investors can own a security which directly tracks the price for a minimal annual fee.

Gavin Graham is Chief Strategy Officer of Calgary-based SmartBe Investments. He is a veteran financial analyst, money manager, and a specialist in international investing, with over 35 years’ experience in global investment management. This is an edited version of an article that originally appeared in the Jan. 30 issue of the Internet Wealth Builder newsletter.

Notes and Disclaimer

The commentaries contained herein are provided as a general source of information, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.

The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. 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.