Unique Research - What are the metals telling us?
Updated: Sep 21, 2021
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You may have seen recent headlines of gold prices hitting record highs. The interesting thing is that silver, platinum and copper prices have been moving up as well. So, what are the metals telling us? We thought this was an opportune time to get perspectives from an investing expert in metals and mining companies. Below are key highlights from Todd Peters, Chair of our Investment Committee, conversation with Matt Haynes (George Family Foundation Chief Investment Officer & Sprott Focus Trust Co-Portfolio Manager) on September 14th. For those that may not be aware, Matt is one of our Alpha Ring Managers with a focus on smaller international companies. Additionally, his firm, Sprott Asset Management, is widely regarded as an expert in gold and natural resource investing. Within Matt’s portion of the Alpha Ring, we have exposure to copper, platinum, palladium, steel, and gold by owning the stocks of three mining companies. Also, the Beta Core portfolio has an allocation to the mining sector through the VanEck Vectors Junior Gold Miners exchange-traded fund (GDXJ).
Why have you kept exposure in metals and mining companies, particularly gold, since the late 1990s?
It is gold’s monetary store of value through history that provides long term insurance against an adverse monetary event that warrants secular exposure in your portfolio. Simply put, we believe that gold is the ultimate reserve currency, and will appreciate when presently reigning fiat currencies fail to provide safety. Fiat currencies are based upon the full faith and credit of the government, but risk losing value if that faith is broken. Having modest exposure to gold as a form of financial “fire insurance” seems prudent.
Gold has appreciated 28.3% in 2020 (as of September 15th), have you been surprised by this move?
Gold prices…and the other metals for that matter…have been moving upwards since the end of 2018. So, the positive trajectory is not a surprise, but the percent increase is certainly significant, and the catalyst has been the pandemic and the associated massive monetary and fiscal stimulus. Gold is considered the anti-dollar. Additionally, sovereign debt has certainly run its course in reducing portfolio risk with rates already close to zero, and stock valuations are high, so this environment has provided an opportunity for investors to pursue metals as an additional potential risk mitigation component in portfolios.
Speaking of stimulus, how do the global central banks factor into this equation?
In Sprott’s Q1 2020 Commentary, we noted that when metals were at their previous high prices (April 2011), the U.S. Federal Reserve Bank and the European Central Bank had a combined balance sheet of $5.5 trillion dollars. Now, that number is a combined $11.4 trillion dollars and moving higher. Yet, gold just recently surpassed its previous high and silver, platinum, and copper are still below their previous highs. This represents a significant imbalance and tells us that metals remain extremely under-owned and under-represented in portfolios.
Beyond the pandemic, are their industry specific considerations that you are following?
There is a phrase in the commodities world…the cure for low prices is low prices. The lower the price leads to a lack of incentive to search for new deposits resulting in lower supply. Lack of supply naturally forces prices to increase should demand remain the same or grow. That is what has happened. Following the April 2011 peak, commodities entered a five-year price decline. Gold declined 44%. Silver declined 72%. Platinum declined 57%. Copper declined 58%. It was a brutal period. Many companies went out of business and the remaining were focused on survival…not searching for new deposits. In fact, there have been few great discoveries for a long time. This situation is now contributing to the potential for further price increases.
How are you looking at owning the metals versus owning the companies that produce the metals?
The key consideration is operating leverage. For simplicity’s sake, let us say that gold is trading at $2,000 per ounce. Should the metal appreciate to $2,200 that would represent a 10% return. Now, consider the impact on a company that has an all-in cost of $1,000 per ounce to mine the gold. Free cash flow generation (price of gold minus all-in cost to mine) goes from $1,000 to $1,200. A 20% increase in free cash flow or double the impact versus the metal alone. This illustrates what we mean by operating leverage. We hope to capture greater upside by owning the companies that produce metals than just owning the metal itself. The companies that survived the 2011 to 2016 period have focused on reducing costs and running operations profitably. They are generating tremendous free cash flow at current spot prices. Should we see a continued uptrend, the impact on corporate profitability would be immense in 2021 and 2022.
Are there different circumstances that impact the demand for the various metals?
While all metals are somewhat related and are driven by supply & demand, there are specific uses for each that play an important role to their longer-term price movements. Gold, for example, is considered both a safe-haven monetary asset, while a significant driver of demand also comes from jewelry production. Silver has a growing industrial element, particularly in “green” technologies. Copper has many applications, most notably in electrical transmission, and is more closely tied to global economic growth. Platinum (and palladium) is a key component in the catalytic converter used in every new gas-powered automobile. Things to keep in mind.
The purpose for gold and the other metals in your portfolio has not changed. In fact, it has been enhanced since the start of the pandemic. With interest rates close to zero and the central banks greatly increasing their balance sheets, this environment should continue to be positive for investments in both the metals and mining companies. Nothing moves in straight line up, but potential for significant appreciation is there. Also, I will be watching to see if acquisitions pick up. Large mining companies needing to replace reserves net of their production might choose to acquire assets rather than to organically search for new deposits. This would be an additional positive since transactions typically occur at premiums to prevailing market valuations.