Gold – the great diversifier

11-29-2023
Gold – the great diversifier

Gold stocks are a leveraged play on the price of gold

 

Most asset classes have delivered disappointing results this year. One exception is large capitalization U.S. technology stocks, known as “The Magnificent Seven” (previously as FAANG+). They include Apple, Amazon.com, Alphabet, Meta Platforms, Microsoft, Nvidia, and Tesla. They have been powered by the excitement over Artificial Intelligence (AI).

Their market caps comprise over 25% of the S&P 500 Composite Index and 30% of Nasdaq Composite Index. The S&P 500 is up 12.5% and the Nasdaq over 28% this year. However, the equally-weighted S&P 500, where each stock has an equal weight of 0.2% of the index, is down slightly.

The S&P/TSX 60 Composite Index is down 4% for the year, while the MSCI EAFE (Europe, Australasia, and Far East) Index is up a marginal 1.5%.

The perceived “safe-haven” government bonds experienced their fourth-worst year in the last three centuries in 2022. The benchmark 10-year U.S. Treasury bond lost over 20% of its value, and we’re seeing another negative return this year. The iShares Core Canadian Universe Bond ETF is off 3.7% this year, and the Core Canadian Long Term Bond ETF is down over 7.5%.

Compare those results to the 9.3% return year to date from the SPDR Gold Shares ETF (NYSE: GLD). Its units each represent one-tenth of an ounce of gold. Gold is back to near its all-time high over US$2,000 per oz., which it touched briefly in 2020 and again after the Russian invasion of Ukraine in February 2022.

Gold mining stocks usually act as a leveraged play on the gold price, as any increase (or decrease) in the metal drops straight to their bottom line. Their results this year have been disappointing, with the iShares S&P/TSX Global Gold Index ETF (TSX: XGD) off 0.5%. But the actual operational performance of the gold miners has been strong, and by some measures gold miners are as cheap relative to gold or silver as they have been for many years.

While investors in Western economies have continued to sell down their gold holdings, with over 400 tonnes having been redeemed from GLD this year, foreign central banks in China, India, Russia, and Brazil have been continuously buying.

Gold as a diversifier

The argument for holding a meaningful position in gold or gold miners (5%-10%) in your asset mix is that it acts a diversifier, as gold is not particularly correlated with bonds, stocks, or cash. Last year, for example, gold was flat while stocks and bonds both went down 20% or more. This year it’s up almost 10% while equities (excluding the Magnificent Seven) and bonds are flat. Of course, this works both ways. Gold touched $1,850 an oz. as long ago as 2011, before falling to $1,150 an oz. in 2015, while stocks and bonds were appreciating.

However, precious metals should be seen as insurance against geopolitical and economic uncertainty, partially because the supply is limited and cannot be easily increased (gold output grows around 1%-2% annually). So, while gold and silver are not a perfect hedge against inflation, they tend to do well when prices are rising. That’s what happened in the 1970s when gold rose over 20 times ($35 an oz. to $850 an oz.) and the 2000s when it was up seven times ($250 an oz. to $1,850 an oz). Gold miners did even better than the underlying metal due to the operational leverage we’ve mentioned.

In the days when wealthy investors used Swiss banks as custodians of their assets, they would always recommend a 5%-10% weighting gold or gold stocks, as preservation of capital was their principal goal. As American humourist Will Rogers said during the Great Depression, "It’s the return of your capital that’s important, nor the return on your capital.”

Gold was one of the few sectors to do well during the 1930s, helped by President Roosevelt’s devaluation of the U.S. dollar from $20.67 an oz. to $35 an oz. in 1934.

Gold has been regarded as a store of value in many civilizations for over 4,000 years. By comparison, the U.S. dollar has lost over 90% of its value since the Federal Reserve was established in 1913, so it certainly seems sensible to have an exposure to gold. True, gold and silver do not generate any income, which is a disadvantage with 5% interest rates available on GICs and government bonds. But many gold mining stocks pay reasonable dividends, which are often linked to the price of gold. Here’s a look at two of the biggest.

Franco-Nevada Corp.

Franco-Nevada Corp. (TSX: FNV) is the largest and longest established of the precious metals/oil and gas royalty and streaming companies, with a market capitalization of $32.7 billion. Its portfolio of royalties and streams is diversified geographically and by different types of metals and energy.

The stock has risen over six times since being recommended over a decade ago while the price of gold has essentially been flat. This has demonstrated the advantages of the royalty model, where the company receives payments of between 0.5%-3% on each ounce of metal produced, without exposure to increases in costs or production disruptions. The price is down over 10% from the date of our last review in January and is 15% below its all-time high of $210 reached after the Russian invasion of Ukraine.

Precious metals accounted for 78.6% of its revenues (64.8% in gold, 10.7% silver, and 3.1% in platinum group metals). Another 17.4% was oil and gas, and the remainder came from iron ore and other mining assets.

Franco-Nevada has a dividend yield of 1% and is the lowest-risk way to play an increase in the price of precious metals and oil and gas.

Agnico Eagle Mines Ltd.

Agnico Eagle Mines Ltd. (TSX: AEM) is the largest listed Canadian gold miner and one of the top three producing precious metals miners in North America. Agnico's portfolio of eleven gold mines are located in mining-friendly jurisdictions, with eight in Canada, including Malartic, La Ronde, and Macassa in Quebec, and Amaruq and Meliadine in Nunavut. Other mines are in Finland, Mexico, and Australia.

Despite increasing its gold output by more than 50% in the last five years, Agnico is only up 40%, and is well below its all-time high of $110 reached when gold first hit $2,000 in 2020. For the nine months to Sept. 30, Agnico produced 2.53 million oz. compared to 2.33 million in the same period in 2022.

Agnico yields 3.1%, and is attractive for its steadily increasing production, partially due to two major successful acquisitions in the last two years, its well-controlled costs, and the locations of its mines in politically stable jurisdictions.

Gavin Graham is a veteran financial analyst, money manager, formerly Chief Investment Officer of BMO Financial, and a specialist in international investing, with over 35 years’ experience in global investment management.

Notes and Disclaimer

Content © 2023 by Gavin Graham. A longer version of this article first appeared in The Internet Wealth Builder. Used with permission.

The commentaries contained herein are provided as a general source of information, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.

The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

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