Gold Is On Its Way To A New All-Time High, But Gold Miners Are Cheap And Might Outperform

Richard Schaefer, Vice President Sales and Marketing of the AMG Fonds provides his personal view on the short term and long term growth potential for gold. Especially gold miners have far more room for growth.

The price for an ounce in gold is climbing steadily and will continue its bullish track which was established at the beginning of 2016. On the short term, we might see some days or weeks a consolidation around the $1800 US-dollar level. But my best guess is, that within the next 6 to 9 months, the old high of $1905 US-dollar will be reached and broken.

Figure 1 – Absolute Gold Price (Uppergraph) and Relative Performance Of Gold (Lowergraph) since September 2011 Source: Thomson Reuters, AMG

My estimation for a continuing rise of gold is made up on three pillars:

  1. Loss of confidence in governments, and gradually decreasing confidence in central banks
  2. Continuous rise of global debt will create a loss of trust in paper currencies
  3. A monetary crisis will start to unfold; central banks are maneuvering themselves into a corner

These days there are even some experts out there who claim that starting from 2021/2022 we might also see some inflation kicking in, which would support an even more aggressive rise of the yellow metal:

Strong Inflation Pushed The Gold Price Up Sharply In The 70’s – Source: Bloomberg, Chart AMG

Most investors took advantage of the latest bull run in gold and bought ETF’s related to gold. Also visible on the chart below, is that jeweler demand dropped sharply due to the current corona crisis. A stabilization within that sector, which normally makes up demand for 50% of a yearly production could support the rising gold price even more.

Demand From Central Banks, ETFs and Bars Are Up +117% compared to Q4 2019 – Source: World Gold Council (WGC)

Now, the above facts and charts clearly support why gold should continue its uptrend and might outperform most other asset classes and also most equity indices in 2020 and beyond. So, if you agree with that view, and you already have physical gold and/or ETF’s in your portfolio, I strongly recommend to switch at least 50% of those assets in an active managed Gold Equity Fund. Miners are cheap, and did not fully reflect yet the performance of its underlying commodity.

This can be seen when comparing gold equities to Gold. Below I inserted a chart which shows this phenomenon. HUI (NYSE Arca Gold Bugs Index)/Gold Ratio 1995-2020

The Longterm Upside Potential For Precious Metal Stocks Versus Gold Is Great – Source: Bloomberg, AMG

The upper chart clearly shows, that miners have found their bottom, after a long long correction to the downside. It also shows, that miners react “ugly” both ways and have a relatively strong volatility, but once investors start to flow into them, the move upwards is exponential.

The long consolidation and correction in the last decade is due to the fact that miners made some heavy mistakes when the underlying gold was at record highs back in 2011. The three most significant were:

  1. New projects with less digging quality and quantity of grade were initiated and realized
  2. A lousy cost control and absolutely no adaption to a stalling gold price in 2011
  3. False promises to investors which weren’t fulfilled, leading to a relatively large amount of dumped mining shares when gold prices dropped after 2011

But that crash and correction in gold miners brought the good virtues back, with costs actively under pressure by a lower gold price. Also on cash costs the industry shows great discipline not seen for almost 10 years, lately the drop energy costs due to the corona crisis are creating room for margins and with a steady rising gold price the margins are increasing tremendously.

Costs And Realized Gold Price As Of 2002 – Source: data by BMO gold mining universe, Chart AMG

As written before, when investors take a bet in this sector, they mostly “hide” either in physical gold or buy a subsequent ETF. Nothing wrong with that, but actively managed gold funds tend to perform better in bull runs and should be bought consequently. When all traffic lights are green and you like to add some steam and leverage to your gold exposure, buying into such a fund can increase your yield.

There Is Still No Euphoria Sentiment In The Gold Sector

There is absolutely no euphoria out there, personally I experienced this lack of euphoria this June. I invited almost seventy prospects in Geneva for a group meeting to discuss and present the status quo of the development in the yellow metal and point out a possible future scenarios, including an extensive risk reward analysis in the gold mining sector. 15 responded, of which 9 declined (mostly due to Covid restrictions) and only 6 confirmed their participation. At the day of the presentation, only 4 people showed up for that event.

More objective proof of  “no euphoria” sentiment in the gold sector can be seen in the chart below:

Price/Cash Flow Ratio = 10x – Source: BMO Research Universum / May 2020

And if we built in that price/cash flow ratio figure of 10x in my last chart, the obvious undervaluation and upside potential for gold miners leaves no space for any doubt or objection:

Gold Miners Undervalued – Source: data Bloomberg June 2020 / AMG

GDX & GDXJ made YTD roughly 21%. When adjusting for the actual gold price, lowering yearly production (due to Covid), but leaving production cost unchanged (which probably will even go down in 2021), leaving P/CF Ratio unchanged and adjusting purely the estimates of the margins, there is still a stunning 30% upside potential!

What Has The AMG-Fonds To Offer?

As Vice-President Sales of AMG Fonds, I would recommend buying the hedged tranche (H-tranche) of the AMG Gold, Miners & Metal fund, with the ISIN# CH0420487941, as I do expect a further weakening of the US-dollar. It currently trades at CHF 125.-, with my personal target being CHF 375.- by 2025. When investing in funds, look out for managers with “no minimum” daily liquidity and look for reasonable management fees (H-tranche: 1,23%). Most important, the experience and quality of the fund manager. The AMG Fonds team has significant experience in this field. Fritz Eggimann has more than 30 years experience in the financial mining business and together with Bernhard Graf, with more than 10 years experience in this sector, they create a team that certainly have extremely thorough and well-developed know-how. Please contact us if you have any further questions.

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