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The investment prospects of gold mines – Part 3

Gold miners and how best to protect your portfolio in troubled times.

Something investors might not be aware of – the Old Mutual Gold Fund holds the top five South African gold miners (70%) as well as six global gold miners (30%) in its holdings.

If one does not have a share portfolio, the best way to acquire gold shares is indirectly is through this fund. It is the only gold fund available through the collective investments (unit trusts) offer.

Over the past 10 years this fund has underperformed all other indices, as it mirrors gold shares. It has delivered a disappointing -5% per annum return.

Until recent times the fund held a big exposure to platinum, and would therefore have best been described as a precious metals fund. With the platinum price falling significantly from $2 300 an ounce to the present price barely above $800, it suffered far more than the gold mining sector. Fortunately, it no longer has platinum exposure and is now fully gold-focused.

Its biggest foreign gold miner is Randgold Resources, and a $6 billion all-share merger between Barrick Gold and Randgold Resources has received shareholders’ approval. This will create a global gold giant that will dominate the African gold industry.

Read: The investment prospects of gold mines – Part 1 

Meryl Pick has managed the Old Mutual Gold fund for the last three years. She is fully invested in gold shares and does not hold any gold exchange-traded funds (ETFs). She remains optimistic about the gold price as she believes there is a high correlation between the gold price and the dollar: “We should see the gold price strengthen on the back of the weakening dollar,” she says, adding that it may not happen straightaway “but we are getting closer”.

The fund is known as being in the highest risk sector because it is so specialised. Its fact sheet recommends that your investment horizon should not be less than five years.

If the gold mining sector is about to come out of its slumber, then maybe it is a good time to invest while its share price is still low. Those long-term holders of the fund may yet be handsomely rewarded for their patience.

Source: The JSE

The Old Mutual Gold Fund chart above illustrates that the price has broken through the 200-day moving average (red line) over the last 12 months – if it can hold it, it is very significant.

Read: The investment prospects of gold mines – Part 2

What happened to the gold miners in the Great Depression years?

Let’s briefly examine a ‘worst-case scenario’ by considering the terrible crash of 1929, which led to the Great Depression. The Dow Jones (the top 30 US Industrial companies) fell almost 90%. The index went roughly from 400 to 40. It was the most devastating collapse ever. It took a mammoth 25 years to recover.

Source: Supplied by author

At the time there was a gold mining company known as Homestake Mining. It was the first mining company to list on the New York Stock Exchange.

Its share price did the exact opposite of the Dow Jones. An investor with 10% exposure in it would have made up their losses. This illustrates the value of having at least 5-10% of one’s investable portfolio in gold. Gold is by nature countercyclical.

The US stock markets continue their longest term ever of a bull trend (10 years). There are dangers and investors would be well advised to protect themselves by purchasing some ‘insurance’ in the form of gold exposure.

The 30-year long-term trend of gold in rand terms is intact.

Source: The JSE

If the gold mining sector is poised to finally turn around because of a favourable Mining Charter that helps all stakeholders benefit from the resources in the ground then now may be a good time to start investing in South African gold mines again.

We see that gold shares are extremely cheap – their prices are back where they were in 2001/2. The evaluations are excellent, and relative to other assets such as stocks and the bond market, the gold miners are offering superb value. This has got to be one of the best buying opportunities in many years.

A prudent investment portfolio may look something like this in present times: 60% in equities, 30% in cash, and 10% in gold.

David Melvill is an independent investment advisor based in Montagu.

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Sorry David, but insinuating that gold shares outperform in recessions is greatly misleading using your great depression example.

Only reason SA gold shares seem to fare better is because they are rand hedges. Recession = weak rand = rand hedges outperform in rand terms but not USD terms.

Gold is countercyclical – NO. Gold is insurance: NO

It has a rough 90% inverse correlation with the USD. Weak $ = strong Gold price. Only time you should be betting on gold is if you think the USD will collapse. It is the best predictor of Gold price. Nothing else.

In most recessions, the USD tends to go up (flight to safety) and GOLD stable or down. Last recession Gold dropped from ~$1000 to about ~$750.

I think it is important to note that we, as South Africans, must always measure gold in Rand terms. Please revisit the 30 year Rand chart of gold above.

You will see that gold kept its trend, it moved steadily up over the last 13 years from 2005 starting at R 2000 an ounce to the present R18 000. that is 9x growth. That is very consistent and very rewarding. It is hard to argue against that fine performance.

Gold price is related to real US interest rates. In an inflationary environment where interest rates < inflation, gold price goes up (e.g. 2012).

Is the US entering a high inflation period? An argument has been made that there has been a structural change to low inflation due to productivity increases made possible by technology. But who knows what the Trump effect may be?

Problem with a gold investor is that one always hears the refrain "gold's time is coming, just not today". I am sure that they will be right, eventually, but that is a problematic investment strategy as most people will capitulate after suffering years of losses.

I think Meryl Pick might be in for a rude awakening if she expects a weakening US$. The correlation that she alludes to between Gold and the US Dollar – is actually between Gold and US Interest rates. She actually then expects the Gold price to rise on falling US Interest rates! That is not going to happen.
I just read an article wherein AngloGold Ashanti is considering listing its shares in either London or Toronto, in a move that could see the company hive off its remaining South African operations.
After South Deep’s fun and games (Kebble-gate, Investec-gate, toxic Gold Hedge book, KPMG and Gold Fields buying an overpriced Western Areas book etc.), the gold mining industry is under severe stress. Don’t buy gold shares (you are buying bad management) – buy the physical for a hedge!

Whenever I feel the urge to buy gold, or when I become bullish on gold mines, I just buy Caterpillar. Caterpillar is yellow, scarce, a store of value, pays a dividend, and since 1980 the value in terms of gold increased 10 fold. There you go- Caterpillar – the superior, dividend-paying yellow metal.

If it is “prudent” to have 60% of your investment in equities, then losing money is considered to be prudent.

In 1970 the price of the Dow Jones Industrial Index in terms of gold was 25 ounces. You would pay 25 ounces of gold to buy the index. Today you would only need 18.57 ounces of gold to buy the index. The investor who exchanged gold for a share portfolio lost money over the past 50 years. Why should investors pay management fees to own equities that under-perform cash(gold)?. Yes – they will say that equities pay dividends, but the dividends are equal to, or less than the management fees! The investor who exchanges his gold for equities, is in fact subsidizing the whole investment industry.

According to the article, the average investor should use 60% of his pension to subsidize his investment manager.

Now we opened a whole new can of worms!

Now compare the returns of physical gold to those of gold miners over 10 and 20 years.

FTSE/JSE Gold Mining Index in terms of gold: ounces to buy the index
1995 3 ounces
2002 11.5 ounces
2018 1 ounce

Over the last 16 years the index lost 91% of its value in terms of the commodity they produce. This situation is basically similar to the Soviet Union that mined coal at double the price they could import it at, just to employ the mine workers. But then again…it describes the whole South African economy under ANC rule.

This confirms what we already know – “gold diggers” are hazardous to your wealth.

If you are an investor, don’t read this next post without a stiff whiskey in your hand. If you are an investment manager, you should not read it at all.

Who is generally considered to be the best investment manager on earth? The guru, the oracle of Omaha, the great Mr. Warren Buffet. Well, Berkshire Hathaway sold for 0.16 ounces of gold per share 20 years ago. You can buy a BRKb share for 0.16 ounces of gold today.

All those groupie trips to Omaha to glorify the beneficiary of the devaluation of the currency, while the real “miracle worker” is the head of the Federal Reserve.

Incredible! Glad I gulped that down with a beer in hand.

There are indeed bitter few that outperform inflation (hence currency depreciation) over the Long term.

I’ve always believed the only way to outperform is to use leverage during the course of a bull market (part of it at least) and through dip buying and then shorting/hedging in a bear.

Buy and hold has its merits but also its limitations in the glorious FIAT money expansion world.

Inflation is a stealth capital gains tax on savers/investors. The only way to earn this tax and not pay it, is to use gearing. Risk increases in proportion to gearing. Inflation forces us to take risk. Risk means that some will go bankrupt. This is how devaluation and credit expansion cause financial crisis.

I received this mail from a reader of these articles, who used to live in Jo’burg. It is always good to hear a good first hand story about a Krugerrand investment.

“I started trading on JSE 2 Jan 1969. So 50 years. I still follow it daily via Sharenet and have a few minor investments still in RSA. I still own I KR bought for R35 in 1969 or 1970. Then R35 was real money. I earned R300 p m after deductions.

If you begin in 1969 when gold bullion was $35/oz. (=R35/oz.) to today of $1250 (R17,500), then compound per annum the price has risen 7.5% per annum in dollar terms and 13.25% per annum in Rand terms over the 50 years.

So a satisfactory rand hedge, but not a good dollar result. Kind regards David in Vancouver

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