Optionality in Gold Stocks
Tuesday, 7/15/2014 15:35
"Stomach needed" for buy-and-hold in gold miner stocks...
CHRIS MANCINI is a research analyst for the
Gabelli Gold Fund, specializing in precious metals mining companies.
With over 15 years of investment management experience, including research analyst positions at Satellite Asset Management and R6 Capital Management, Chris Mancini spends his days seeking value in gold equities – and he thinks he's found a recipe for success, as he explains here to
The Gold Report...
The Gold Report: Cash has flown out of gold funds and into non-gold equities during this bear run in gold. What's the current Gabelli Gold Fund pitch to investors?
Chris Mancini: Gold should be a long-term allocation to everyone's portfolio. Owning gold is an insurance policy against the malfunctioning of the world's monetary system. The current actions of the world's central banks are unprecedented. Any investor who is unsure of the ultimate outcome of these actions should have a larger percentage of his or her portfolio in gold.
We recommend that investors have a certain portion of that gold allocation in gold stocks. Gold stocks provide income, accretive growth and "optionality." That optionality is gold in the ground at a discount. Right now investors can buy gold in the ground, in some cases, at less than $100 per ounce and if gold goes to $2000 per ounce then they could see that optionality manifest itself in a big increase in the price of the stock.
TGR: So it's possible to have security and performance in the same fund?
Chris Mancini: If you pick the right stocks and have that optionality and gold goes up, the performance of the fund will be really good. By the same token, if gold goes down and you own some of these stocks, the price of the fund will most likely go down. In owning a gold fund like ours investors are getting exposure to gold and leverage to a move in the gold price.
TGR: Gold witnessed modest safe-haven and inflation-hedge demand in June after US Federal Reserve Chairman Janet Yellen said that low interest rates are here to stay. Should gold investors expect anything more than a temporary upward trend in gold prices?
Chris Mancini: That depends on the expectation in the markets of where real interest rates are going. Yellen stated that interest rates would be lower for longer but that was coupled with data that showed that inflation in the United States could be accelerating. That shows that real interest rates might become more negative than they are now. And that means that holding cash is a money-losing proposition because cash is losing purchasing power. If interest rates become more negative, that will be positive for gold and it won't be a temporary phenomenon.
TGR: What's your price target for gold through the end of 2014?
Chris Mancini: We don't have one. Our view is that the price of gold is going to be higher at the end of 2014 than it is now. And it's going to be higher in 2015 than it will be in 2014 and we're positioning the portfolio to take advantage of that.
TGR: What impact have redemptions from gold exchange-traded funds (ETFs) had on the gold price?
Chris Mancini: Last year 900 tonnes came out of gold ETFs and it was a huge contributing factor to the price of gold declining by 27%. Total annual gold demand is roughly 4,200 tons so if the supply from ETFs goes to neutral then the supply/demand balance this year should shift in the other direction. This year we've seen a tiny negative outflow from ETFs, but they've been pretty flat. Inflows into ETFs would be a big positive for the price of gold.
TGR: How do the inflows and outflows in your fund compare with 2013?
Chris Mancini: At the beginning of 2014 we had inflows into the fund, and then they flattened out. When we had the big one-day pop in the gold price in June when gold went up $44 per ounce, we actually had outflows from the fund. That might be telling us that we have some people who are playing gold for a quick bounce and aren't looking at gold from a long-term perspective.
TGR: A recent Gabelli Gold Fund report suggests that Russia may want to diversify its foreign exchange holdings and could look to gold.
Chris Mancini: Russia has around $500 billion of foreign exchange reserves in the form of US Dollar Treasuries and Euro-denominated bonds, largely German, French and some other smaller European country bonds. If there is further geopolitical unrest in or around Russia and increased rhetoric from countries like the United States, Germany, and France meant to impede Russia from taking action in places like Ukraine, Russia might get the sense that the United States and other countries in Nato might impose financial sanctions on Russia.
If broad financial sanctions are placed on Russia, then there could be a question as to whether Russia would be repaid by the countries that they've lent money to. In a new Cold War scenario, you would think that Russia would want to diversify out of the bonds of those countries and into something else. What else is there? Gold is an answer. Gold is no one's liability.
TGR: Where is China in the gold demand picture?
Chris Mancini: Chinese consumers are the largest buyers of gold in the world. That's related to their fear of holding their currency in the bank or holding it in their mattress. There's a significant amount of inflation in China, so real interest rates are negative. It behooves the Chinese to diversify out of cash, which is losing its purchasing power. Holding gold is a way to insure against inflation or some kind of issue with the Chinese banking system.
China has around $3.7 trillion of foreign currency reserves. The People's Bank of China also might want to diversify. If China were to diversify 10% of its foreign currency reserves, $370B, that would be a huge amount of gold to buy, or roughly 3.5 years of the world's total mined supply of gold.
TGR: A significantly higher gold price would float all boats. But until that happens, what's your method for picking gold stocks?
Chris Mancini: We try to own the companies that can survive and even benefit from this downturn and then prosper in the upturn. We look for companies that have good assets, good management and a good valuation. Good assets alone should allow the companies to survive; their management teams should help them prosper. We're looking to buy these companies at reasonable prices.
TGR: What's one thing a gold investor should know about the current market?
Chris Mancini: The best thing to keep in mind is that even though this market is extremely volatile, you're in it for the long term. It was very volatile to the downside last year; so far this year it's been volatile to the upside. Don't lose hope or exit on a quick run up. You're getting insurance at a relatively cheap price by owning gold and gold mining companies.
TGR: Buy and hold still works?
Chris Mancini: Yes, if you have the stomach for it.
TGR: Thanks, Chris.
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