James Withall: The gold price in Euros is positive for the year and investors who engaged in active stock selection have had the chance to achieve higher returns than in many other types of equities. The lessons learnt this year reinforce my experiences from previous bear markets, specifically that if an investor is willing to trust their judgment and follow a contrarian investment strategy at the bottom of the market the potential returns can be significant.
e-fundresearch.com: What arguments and drivers are currently suggesting a recovery of the gold price and gold equities?
James Withall: The US Dollar gold price remains overshadowed be the expectation of a rise in the Federal Reserve interest rate and commensurate strength in the US Dollar. A rise before year-end could well be discounted in the current US Dollar spot price but we expect that in the short term the gold price will remain volatile and accept there is further down side risk. Our analysis of the price performance of gold following the first rate hike in previous tightening cycles shows that in recent times gold has performed well during those periods. Furthermore, it is likely that real interest rates will remain low for the foreseeable future and this combined with continuing concerns of long term monetary debasement, create an environment conducive to a gold price recovery.
Physical demand for gold both for jewelry and investment remains robust. In particular Chinese demand is strong; the People’s Bank of China recently declared a 57% increase in official gold reserves in July and has been adding at a rate of approximately 15 tonnes per month since then. Also noteworthy is the Russian central bank increasing its holdings by 160 tonnes in the first 10 months of 2015.
"(...) the shares are at levels seen towards the end of the last long bear market in the late 1990’s"
It is worth pointing out that gold has performed well in other major currencies, including the Euro and has recently made record highs in a number of emerging markets, such as Brazil, Turkey and South Africa. The relative weakness of commodity currencies where much of the gold producers are located has been a positive factor for gold equities as cost of production have reduced. This is translating into good margin expansion and for some selected gold companies they have far higher margins and greater cash flow generation than at any time in the past ten years.
Looking broadly at gold equities today the share prices of established producing companies that make up the sector indices are at extreme relative lows to the price of gold. What the market is paying in terms of market value per ounce of annual production, the shares are at levels seen towards the end of the last long bear market in the late 1990’s.
e-fundresearch.com: To what extent can gold and gold equities provide a hedge against the potential impacts of loose monetary policies of the world’s major central banks?
James Withall: Gold is truly scarce and it is a unique financial asset, which is nobody else’s liability – it carries no counterparty risk – a unique quality, which protects the holder’s purchasing power. The long-term consequences of large scale quantitative easing and zero or negative interest rate policies are still to be understood. Gold’s role as insurance in times of financial uncertainty is reason alone to consider an allocation in one’s portfolio.
"Selected gold companies that have robust balance sheets and are already experiencing margin expansion (...) could also qualify as portfolio diversification investments"
Gold Equities provide an investor with operational gearing to a rising gold price and hence tend to outperform gold in a rising market. With gold equity valuations so suppressed at the current time due to the overall negative sentiment regarding future gold prices the equities look oversold on a relative basis. Selected gold companies that have robust balance sheets and are already experiencing margin expansion due to a combination of high asset quality and good cost and capital management could also qualify as portfolio diversification investments.
e-fundresearch.com: How would you describe your investment philosophy in one sentence?
James Withall: All members of Baker Steel’s fund management team have a geosciences in addition to a finance background, which is why our investment philosophy is based on fundamental, bottom-up research to identify the best assets and companies, taking into account of the broader risks of investing in mining assets.
e-fundresearch.com: What are the main steps in your investment process and in which area is your competitive edge to add value to investors?
James Withall: Baker Steel’s investment process is primarily based on the firm’s proprietary research database GenVal, which encompasses more than 500 assets and over 200 companies globally in the precious metals sector. Most importantly, GenVal contains notes from each interaction with the management of those companies and due diligence visits to the assets.
The main steps of the investment process are as follows:
1) Identifying the Asset Opportunity, the key considerations being Economic Geology that has the potential to generate excess returns, the Risk Profile (operational, jurisdictional, social and environmental) and Exploration Upside that provide potential for above average mine life.
2) Identifying the Corporate Opportunity, the key considerations being their Asset Portfolio, Balance Sheet strength, Corporate Structure and Management’s Alignment with the equity holders through shareholding and or remuneration structure.
3) Lastly indentifying the Market Opportunity, does the company and management have the Confidence & Trust of the wider market? Over time has Capital Discipline been demonstrated that is matched with a sensible Dividend Policy. These factors contribute to the equity having a positively skewed beta to moves in the price of gold.
Once a potential investment has been identified using the steps described the investment team meets to discuss whether the opportunity has a better risk reward than a holding already in the portfolio and or will be complementary to the portfolio and there is cash available to start a position. We run a relatively concentrated portfolio which increases the competition for capital within the portfolio.
e-fundresearch.com: Compared to peers: In which market environment do your investment strategies generally deliver the best (relative) results?
James Withall: The performance of our strategy has outperformed peers in most market environments. Certainly we believe that in periods such that we are experiencing today where there is increased uncertainty as to the gold price we should outperform through active stock selection that should then further enhance returns in times of market momentum.
e-fundresearch.com: How optimistic is your view into the future and what obstacles and challenges should investors be prepared to overcome in 2015?
"(...) we could see momentum build as the gold and gold equities sector moves towards a recovery phase"
James Withall: We are cautiously optimistic in the near term and more bullish for the medium term, particularly for gold equities, which tend to lead a rally vis-à-vis the gold price. We believe that once the initial US Federal Reserve interest rate decision is out of the way, we could see momentum build as the gold and gold equities sector moves towards a recovery phase. Again we would caution that there will be obstacles facing individual companies who are still recovering from past mistakes that were covered up by continually rising prices so would expect there to be significant divergence of individual gold equity performance.
