With the global health and economic shock of the Coronavirus (Covid-19), I feel strongly compelled to get back to publishing thought pieces making use of my decades in the market to hopefully help others.
This insight will cover four Issues. First, a few observations of this crisis, second, an explanation as to why gold has not performed better yet in US dollars, third, why I think gold stock investing is currently the least risky choice now in the metals and mining space, and fourth, the risks to such investing.
We are all looking at the Covid-19 infection curves of different countries. As a data point at the time of writing, China has surprised the world in turning down its curve and yesterday (March 19th) had no new cases. It is now ramping up economic activity and is a relative source of commodity strength. While South Korea, Taiwan, Hong Kong and Singapore are having success in taking on the pandemic, the western world is in disarray. Large parts of the US are joining Italy and other European countries in total lockdown. Globally, many factories and mines are temporality shutting down. There is a hoarding of US dollars as investors panic into cash. As of last night, March 19, the S&P was down 25% YTD, gold stocks measured by the XAU and the GDXJ (mid-sized stocks) were down 30% and 38%, respectively. The Australian dollar which has historically been a good proxy for Asian economic and commodity activity in times of crisis was down 16% YTD. Gold is down about $50 to $1471 per ounce and down over $200 from its March 9 high. However, gold in Australian dollars is up 18% YTD and still above its March 9 high.
Why has gold in US dollar terms not performed better so far in this crisis? Keeping gold elevated at the multiyear US dollar recent highs of near $1700 in this market is like trying to hold up a protective lead blanket over one’s head as the sky falls. The weight of falling equity markets, oil, currencies, Comex long positions and gold ETFs holdings as well as the impact of margin calls is pulling US dollar gold prices down. For at least the moment, we have a hording of cash. This has happened before in the Asian Currency Crisis, at 9/11, during the GFC and most recently in 2015-2016. After things settle, and the dust clears, increased gold investing may increase US gold prices despite the head winds. Certainly, with a sea of financial shocks and global monetary and fiscal stimuli being thrown at the market one could argue it is a perfect storm for gold.
Why are gold stocks the safest investment in our space now? Gold stocks were attractive before the Covid-19 crisis. Margins in many non-US countries had grown to near record levels and this was reflected in consensus free cash flow yields. An investor buyer strike has brought better capital discipline to the market. Those margins are now still approximately the same in local currency as before the crisis. In some cases they are better. Yet gold stocks as noted above have crashed. This makes the gold sector unique to most all other businesses at the moment in having pre-crisis or better margins and materially lower equity valuations. Numerous gold stocks are attractive at the current prices. Two examples of lower risk companies with lower debt and diversified assets include Gold Fields (GFI $4.52) and AngloGold (AU $15.41). Both have consensus average free cash flow yields of over 10% for the next three years.
What are the risks? On the gold price side, a severe economic downturn akin to the Asian Currency Crisis could result in central bank and individual gold selling to pay for stimulus and personal bills. One of gold’s attributes as a store of value is to be there to raise cash in times of need. That was the case in Asia in 1996-1999 when gold fell to near 20 year lows albeit with the help of historic European central bank selling that in turn motivated massive producer hedging. We don’t see these three factors snowballing again, but elements of them may re-occur. Another risk is that the temporary virus related shut downs that miners are taking now will be materially longer than the two to four weeks currently expected. Our base case is that the shutdowns, while a temporary cash flow and guidance set back, will be one off events that will not be overly material for investors with a more than one year view.
In conclusion, this is the time to buy gold equities especially if you are bullish or even neutral on gold. I don’t ever recall seeing the sector this cheap relative to expected profitability and free cash flow yields.
We hope our readers stay safe and healthy during this crisis.