In this article, Guillermo Felices, BNP Paribas AM’s Global Head of Investment Strategy, and Daniel DiFrancesco, Global Emerging Market Equity Analyst, explain why there are still plenty of nuggets of investment opportunity to be found – in gold itself and in some of the companies that extract it.
Gold rallies tend to be long and persistent – the latest upward move started toward the end of 2018 (see Exhibit 1). This rally has underlying drivers that make us think gold – and the better-managed producers of it – still have some way to go in terms of investment potential.
Rock-bottom interest rates and aggressive fiscal stimulus are supportive of gold
Gold offers no income stream or yield. However, it is both an asset that can survive financial meltdowns and a hedge against inflation since it is in limited supply and is generally seen as a ‘safe currency’ when inflation is on the rise. During periods of very low interest rates with inflation seen as one way of reducing debt burdens, the yellow metal becomes a more interesting option as a safe haven. After all, gold is essentially like a currency, but one that cannot be debased by central bank actions.
Given the significant challenges it is facing, the US Federal Reserve has said that both its recent shift in monetary policy to one of average inflation targeting and its aggressive easing stance are set to remain in place for a long time. One upshot of this has been that the US dollar, after years of appreciation, has more recently lost value versus other major currencies. And – as has happened at such times in the past – gold prices tend to rise when the dollar slips.
Whether inflation remains low or (eventually) starts to rise, gold can be an attractive diversifier – as a hedge at times of higher inflation and as a safe haven against the risk of central banks keeping nominal interest rates at ultra-low levels.
Increasing demand from financial investors
A look at the change in the demand profile for gold – who’s buying it – shows a rapid increase among financial investors. In the past, a rough split of demand would have been 50% for jewellery, 30% by investors (coins, ingots, etc.), 10% by central banks as part of their reserves, and 10% for use in other products.
Today, demand from the last two categories remains about the same. However, jewellery demand has halved this year to about 25%, not least because of shops being closed because of COVID. Demand from investors, by contrast, has soared to about 55% of the total. For example, the number of exchange-traded funds (ETFs) holding gold has mushroomed recently, with global inflows rising by 34.5% in the year to date.
So, for these reasons – low interest rates, a weak dollar and new investment demand for a commodity that has limited supply – our 12-month forecast for average gold prices is USD 2 200–USD 2 300 per ounce, and as to our own investment stance, we are structurally long on gold, while managing this tactically.
Digging the guys that dig the gold. That could pan out, too
Investing in gold is one thing, but there also are numerous reasons to consider investing the companies that mine it. Most of the major producers have a sizeable exposure in emerging markets, while their shares are mainly listed on exchanges in the US and Canada. So, points for diversification.
It is also worth looking at some of the realities of gold mining currently. Global supply looks set to decline over coming decade, and discoveries of major new seams are becoming rarer. Limited supply clearly in itself supports prices. Companies for which gold is a by-product – copper miners, for example – are finding the going tougher in the face of increased environmental regulation and harder-to-reach copper sources, which gives the primary gold producers an advantage.
Indeed, many primary producers have been focusing more heavily in recent years on spending to lower costs and improving margins. They are managing to generate free cash flow and increase their net cash, so there are certainly some among them with healthy balance sheets, less debt and strong dividend per share growth. We are seeing helpful consolidation in the industry, which tends to generate a more attractive proportion of well-managed companies.
Strong fundamentals still underappreciated
We believe some of these strong fundamentals remain underappreciated by potential investors, as shown by a general under-allocation to gold. The investible market capitalisation across the industry is relatively small – the total across the whole precious metals industry is about USD 442 billion, compared to USD 6 909 billion for the five top-performing tech stocks.
However, increasing investor interest could have a major positive impact, not least given that the current macroeconomic factors are providing strong support for gold prices.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.