For the year 2019 (Dec. 28th, 2018 to Dec. 30th, 2019), gold increased by 18.3% in USD. The XAU Index gained 21.2% during Q4, 19 (USD) and ended the year with +53.8% (USD). Nestor Gold Fund (USD) gained 12.6% in Q4, 2019 and increased by 54.9% in 2019. The fund outperformed in 2019 physical gold, its benchmark and the peer group despite the fact that small and mid caps underperformed the larger cap names. This is thanks to successful stock picking within the mid to large cap producers.
Gold continued its consolidation during Q4, 2019, but ended the quarter positively thanks to an increase in December. Expectations for FED cuts in 2020 decreased sharply amid rising hopes of an economic recovery in 2020. As a result, short-term sentiment towards gold switched from bullish to bearish. Despite these developments, gold held up nicely and miners ended the quarter with gains; very constructive signs. Gold miners’ Q3 results 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.
Outlook 2020
It is fascinating to see how the consensus economic view has recently improved, which is often seen around year-end. Besides the fairly typical seasonal rise in economic optimism, it is also helped by the recent phase one resolution of the trade war.
Nonetheless, we would like to address a few reasons why any potential economic recovery will be sluggish and is unlikely to be sustainable:
- Structural issues (over-aging, excessive indebtedness, consumer saturation) are not resolved and getting continuously worse.
As a fact, it is interesting to see that the average growth has declined in each decade since the 1950s. The fact that the recovery in the US (and Europe) since the 2008 recession was the slowest one ever experienced (despite the most expansive monetary and with a heavy fiscal stimulus in the US) should remind investors that the new normal will be a lot different from the world before 2008!
While the phase one resolution of the trade war probably averted a further near-term economic deterioration, it is obvious that the war on global leadership (what the trade war is really about) will continue, and that the environment for higher capex investments isn’t here in 2020 (at least, maybe much longer), nor needed given the low capacity utilization.
We must get used to the idea of zero to one percent growth in the industrialized world. However, this reality is acceptable to neither the political leaders (Mr Trump, etc.) nor the leading central banks, who are all striving for higher growth.
This brings us back to the key reasons, addressed in our Q3 report, why gold will likely continue its rising trend in 2020:
- Start of interest easing cycle (2018), which will go much lower than consensus currently expects.
- Acceleration of the currency war. The US will now likely go into the lead again (in the “race to the bottom”), due to coming interest rate cuts.
- Confidence crisis (seen so far at the political establishment) has started to spill over to central banks, with many triggers, as written about in this report.
- The fact that a normalization of interest rates isn’t possible has come to investors’ minds, but not yet into the tactical/strategic asset allocations. This process has now started and will be supportive for gold in the next few years.
As these reasons will likely be here for many more years, we would like to elaborate in this report a little bit more in detail about the starting confidence crisis at central banks, as there are currently important changes going on, which haven’t really caught the necessary attention yet.
Cornered central banks looking for new ways to justify ultra-loose monetary policy
The year 2019 illustrated that the normalization of interest rates is not possible and that a balance sheet reduction is not as easy as an expansion. From our point of view, the main central banks (FED and ECB) are working on a new framework, which will allow them to hold (or even reduce) interest rates at the historic low levels and expand the balance sheets for many more years. This year FED rate cuts were mostly justified by economic risks (trade war and Brexit). However, at the last meeting the FED argued that a trade war solution would not trigger higher interest rates and changed the focus to inflation. Interestingly, both central banks are currently working on a new framework, where inflation is at the center stage. The FED is thinking about an “average inflation targeting”, which would allow them to overshoot in the coming years. The ECB, with the new President Christine Lagarde, talks about a “tolerance band of desired inflation” rather than its current point target, which one could translate as an increased inflation target too. According to rumors, the ECB could support the fight against climate change by buying green bonds, which would be another reason for increased QE.
To sum up, the FED and ECB will reason the ultra-loose monetary policies with whatever it takes, because they are cornered and are not able to return to “normal monetary policy”. More and more investors realize that, but the necessary changes aren’t implemented in the tactical/strategic asset allocation yet. This process has now started and will be supportive for gold and other real assets in the next few years.
Other very constructive and confirming signals
While the macro and monetary environment continues to be very positive for gold, it is always worthwhile to check whether the market signals confirm that view. Currently, it is very promising to see that:
- Breath within the larger gold miners hit a multi-month high (leading the index);
- Gold miners started to outperform physical gold. It is especially noteworthy that this happened during the Q4 gold price correction;
- Junior gold miners started to outperform the larger gold producers.
Given that these signals have historically been fairly reliable, they support our “bull market thesis” for gold and gold miners.
Potential benefits of adding the Nestor Gold Fund to a portfolio
The fact that interest rates will likely stay low (or go lower, given the sluggish economy), means investors will likely look for alternatives which benefit from low real interest rates. While in the last seven years, investors had a frustrating experience with gold miners, it is interesting to see how our funds performed during gold bull markets (Nov. 2000 – May 2001; Oct. 2008 – Dec. 2008; Sept. 2018 to now).
It is a fact that our investment products returned about 50% per year (and outperformed the index tracker by 15% per year!) during the bull market periods in the last 20 years. There are currently very strong indications that the bull market, which started in January 2016, is still in place and will not end in the near future.
As a result, it becomes clear that already a relatively small allocation of the Nestor Gold Fund can provide significant return benefits to any investment portfolio. As an example, already a 4% allocation would imply 2% return contribution to an overall portfolio per year! In addition, the fact that the correlation of the fund to other risky assets is low will likely reduce the total risk of any portfolio, which is just another benefit. Especially in a world where investors are more and more forced into more volatile/risky assets (due to financial repression by global central banks), the diversification benefit should not be underestimated.
Conclusion
While consensus is getting back to the traditional (and seasonal) economic recovery scenario, we can’t see any meaningful and/or sustained economic upswing, given that all the structural headwinds are still in place (resp. getting worse every year).
The positive environment for gold continues to be supported by:
- Start of interest easing cycle (2018), which will go much lower than consensus currently expects;
- Acceleration of the currency war. The US will now likely go into the lead again (in the “race to the bottom”), due to coming interest rate cuts;
- Confidence crisis (seen so far at the political establishment) has started to spill over to central banks, with many triggers, as written about in this report;
- The fact that a normalization of interest rates isn’t possible has come to investors’ minds, but not yet into the tactical/strategic asset allocations. This process has now started and will be supportive for gold in the next few years.