While all that glisters may not be gold, global fund manager Schroders has broken its own tradition and bought gold stocks.
Head of Australian equities Martin Conlon said: “We must make a confession. During the quarter, for the first time in at least a decade, we purchased a gold stock, Newcrest Mining.
“Having pilloried gold companies for some time, we owe an explanation. Valuing gold is almost impossible. It has value only in so far as others accept it as having value in exchange. In this function it is obviously similar to money.”
On the other hand, Hyperion chief investment officer and investment committee chair Mark Arnold eschewed gold stocks, saying the Australian equities fund bought only when “the long-term intrinsic value” could be assessed with reasonable certainty.
Between these two poles, AMP Capital Australian resources analyst Andy Gardner agreed with Warren Buffett’s assessment in his shareholders’ letter last year that over 100 years “gold offers no real return on an absolute basis”, but Gardner tempered that with the reality that “over a much shorter time frame the investor must navigate the path laid in front of them”.
“Good-quality companies that meet our requirements are rare. But when they come along we of course buy them, just like any other mining company. In that respect gold companies are no different from any other. Regis Resources is one such company,” he said.
Conlon said that with tail risk at “undoubtedly elevated levels, we can see value in buying some sensibly priced insurance”.
“Our rationale for purchasing exposure to [gold] lies in the uncertainty over how investors will react in the event that the enormous pool of assets known as the bond market can no longer be artificially sustained,” he said.
If investors lost faith in these ‘risk-free’ assets sustaining wealth, they would seek refuge elsewhere, he said. “Gold may be one of these ‘elsewheres’,” he said, adding that Newcrest Mining could be justified on gold prices well below current levels.
Arnold countered that the basis of intrinsic value was the long-term sustainable free cash flows of a business. “If we can’t assess the future free cash flows with a reasonable degree of confidence, particularly in downside risk, then we can’t calculate an intrinsic value,” he said.
A key input was the future gold price, which was hard to assess with any reasonable level of confidence. Gold mining businesses also tended to have volatile production levels, volatile production costs and capital investment requirements.
Gardner cited Buffett’s observation that, on a relative basis, gold would underperform a portfolio of well-selected inflation-hedged assets, such as oil companies and cropland. These assets exhibited much greater leverage to the two main pillars of economic growth over the long term: productivity and demographics.
Investors currently faced deleveraging, the unwinding of a very different kind of cycle – the accumulation of debt over the past 70 years – and were concerned with the return of their capital, not just the return on their capital. In this environment, some exposure to gold made sense, Gardner said.
As to gold being an insurance policy, he said he was wary of going long on poor operational and financial performance, rather wanting a commitment to pay a meaningful dividend yield, which physical gold could not deliver.
Unfortunately, he said, most Australian and global gold stocks had “none of these benefits given the headwinds of a stubbornly high Australian dollar, escalating capital and operating costs, increasing taxes, lengthening approval processes, and the lack of a disciplined approach to capital management”.
“It is rare to find a gold company that can create value for shareholders as Regis Resources have done. But with the ability for investors to hold bullion, it is a rarity worth waiting for,” he said.
