As of June 28th 2019, gold bullion closed at EUR 1,240.82/oz., an increase of 7.7%. The FTSE Gold Index gained 15.6% (in EUR), while the NESTOR Gold Fund increased by 7.5% (EUR). The underperformance is due to the junior gold miners, which were lagging the benchmark significantly. The lagging of the smaller cap names is a typical behavior often observed at the start of major bull markets. In addition, the silver equities were lagging even more and Yamana and Iamgold underperformed. Positive performance attributions came from Gold Fields, Anglogold, Detour, Semafo, Eldorado, Alacer and Alamos.
Gold increased thanks to weak economic data, which led to a turnaround in FED Fund expectations. Gold miners published Q1 reports which were generally in line with expectations. Given the low valuation, operating and financial leverage as well as continued industry discipline, we continue to consider gold equities to be in the sweet spot of the industry cycle and therefore they are expected to outperform physical gold significantly in a rising gold price environment.
Gold breaking out, finally!
The gold price has reached a 6-year high, after the FED demonstrated the willingness to cut interest rates. With that move, as seen below, the gold price has finally broken through the key resistance at USD 1’370. Therefore, not only the fundamental situation (high indebtedness, economic slowdown and turn to dovish monetary policy) but also the technical situation indicate higher gold prices.
Chart: NESTOR Gold Grafik 1
Is this break-out sustainable and is a new major gold bull starting?
Given the fact that gold broke out amid additional gold supportive factors like rising geopolitical and trade war tensions, the skepticism from the broader investment community towards gold and gold miners continues to be very high.
However, we consider these additional factors as less relevant and can see the key reason for the economic slowdown, which will likely lead to a major turnaround in the US monetary policy, which points to a lower US dollar and lower real rates, both affecting gold and gold miners very positively.
The agreed truce at the G20 meeting in Osaka between the US and its trading partners (the focus mainly being on China) could in the short term lead to a retest of the break-out. However, we are convinced that the trade and technology war with China is unlikely to end before the US election in the
Autumn of 2020 and therefore it is unlikely to change the new intermediate to long-term bull trend in gold.
Consensus is ignoring the fact that almost 100% of the growth in the US economy was thanks to rising consumption. Given that, since the great crisis in 2008/09, the correlation between wealth effect and consumption has risen to 75 - 90%, it becomes clear how much the zero percent interest policy and the different rounds of quantitative easing have contributed to the (low) growth exhibited in the US and Europe. Without the boost of rising real estate and equity prices, the US and all other parts of the industrialized world would have been oscillating around zero growth for the past ten years, something most strategists, analysts and investors often forget these days. This is the “new normal” for the industrialized world (including the US).
This low growth, together with inflation below the FED target of 2%, will lead to rate cuts in the next six months. The FED - according to our knowledge – is currently discussing internally additional policy tools, which will surprise the market and are likely to act as major catalysts for gold and gold miners.
All these potential new tools will likely weaken the US dollar and have the potential to question the confidence in the FED. As confidence in the FED, the US dollar and government bonds are even more relevant for gold than real rates and the US dollar (which are both supporting the bull case as well), the likelihood that a major gold bull market is in the making is very high.
How did our funds react to lower FED funds?
Historically, having a position in our gold mining funds paid off very handsomely when the FED started to cut rates. The prices of our funds have multiplied and initiated major bull markets when the FED turned from hiking to cutting rates.
Chart: NESTOR Gold Grafik 2
Additional factors giving us confidence that the break-out is sustainable
In addition to the very positive macro factors impacting gold, we also have very constructive signals from the behavioral finance side. These are:
- Capitulation of the gold mining fund industry. Repositioning (kind of closing) of the > 2bn gold equity fund at the largest asset manager in the world (Vanguard). Closure of many Canadian gold mining funds and exit of many funds from the small cap segment.
- Capitulation of the gold mining industry with merger Barrick/Randgold, Newmont/Goldcorp and Yamana selling one of its assets to halve indebtedness.
- Capitulation of gold and gold mining investors. Outflows of gold ETFs till a few weeks ago. Major outflows at active and passive gold mining funds in the last twelve months. Deletion of gold from the strategic asset allocation at one of the largest insurance companies in Switzerland in Q1, 2019.
We consider the behavioral finance as very important (when the last bulls give up in a bear market, it usually can only go the other way) and given that similar actions only happened in 2000/01 and H2, 2015, this supports our thesis that we have just passed a major inflection point.
What is likely the best way to play a major gold bull market?
In the first few years of a gold bull market, gold miners tend to perform significantly better than gold. Historically, our funds did outperform physical gold in the initial phase by a factor of 5 to 10. The key reasons are the following:
- Heavily underweight positions by generalists
- Very cheap valuation of gold miners
- Ignorance of the small cap segment, which until very recently performed significantly worse (despite fundamental improvements such as increase in reserves and resources, etc.)
Therefore, it will most likely be rewarding to buy or increase positions in the NESTOR Gold Fund, as we expect a significant outperformance vs. passive and active peer products, as exhibited in previous bull markets. Details can be seen in the chart below.
Chart: NESTOR Gold Grafik 3
Sources: Bloomberg, Konwave AG
Conclusion
After many years of frustration for precious metals investors, gold has finally broken out (confirmed on a monthly and quarterly basis, i.e. to be taken seriously). The start of an interest rate cutting cycle by the FED, which will likely lead to a lower US dollar and lower real rates, is very positive for gold equities. In addition, according to our knowledge, the Fed will likely surprise the market in the future with (new) policy tools which haven’t been used for decades, and perhaps never before! This will accelerate the loss of confidence in the FED, the US dollar and government bonds, all supporting the thesis of a new multi-year bull market in gold and gold miners.
While many peers have been exiting from the junior/developer segment in the last few quarters (and made their funds more defensive), we are sticking to our long-term strategy. Given the record high valuation discount of the junior/developer segment, we are convinced that our strategy will pay out and therefore expect that the fund will beat comparable active and passive products significantly, as it has done in previous bull markets.