Home Dr. Kohlhase Vermögensverwaltungsgesellschaft mbH

NESTOR Gold - Quarterly Report 1/2022

We consider this to be the most relevant quarterly report since late 2018, when the last major inflection point for gold miners happened! We observe many similarities to 3½ years ago, when the world was dreaming about interest rate normalization and interest in gold was very low (like now, just after a period of big outflows from gold ETFs).

Given the current valuation and disinterest in gold miners, we wouldn’t be surprised to see a similar scenario to 2018 developing over the next few months and are very optimistic for 2022!

So let’s start with a quick review and afterwards, what drives our high-conviction, non-consensus view.

As of March 31st, 2022, gold bullion closed at US$ 1,937.44/oz., an increase of 6.8% QoQ. The Philadelphia Stock Exchange Gold and Silver Index increased by 20.3% (USD) / 22.8% (EUR) during Q1, 2022, while the Nestor Gold Fund (USD -B- share class) gained 14.3% (USD) / 16.7% (EUR). The fund underperformed in Q1, 2022, as small and mid caps lagged substantially, a behaviour often seen at the start of major gold bull markets. A similar behaviour was seen in late 2000/early 2001, late 2008/early 2009, and also in late 2018.

The gold market benefited, after massive outflows during 2021, from a recovery in gold ETF demand. While most participants see that as a sign of the geopolitical situation in Eastern Europe, we consider much more relevant developments, on which we will comment in this report. As in Q4, 2021 gold ignored the continued US Dollar strength and the rising long-term yields, a very strong signal.

Gold miners reported their 2021 results, which were generally in line with expectations. Given the continued inflation pressure, cost guidance for 2022 was generally a bit higher than expected. Unlike most other sectors, gold miners results will likely be more than compensated, as gold will benefit from rising long-term inflation expectations and earnings revisions will likely be upped strongly during the next few months given that consensus still expect lower gold prices in 2022!

Economic and inflation outlook
We are in Q1, 2022 in a stagflation-like scenario. However, the market looks to more growth and a substantial decline in inflation. What drivers will affect the economy and inflation over the next few months?

The US economy is suffering from a strong USD and rising commodity prices, the so-called “growth tax” (see chart below). This should have a pronounced negative impact on the economy during the next few months.
Source: Alpine Macro

Europe is suffering from the weakening 2021 economy in China (delayed impact), the war in Ukraine and the sharply rising energy costs in many countries. All this questions the consensus view that the economy rebounds after the omicron wave in Q1. The above-mentioned reasons, together with much lower fiscal and monetary stimulus, declining real income due to high inflation, tough comparables (unlike 2020 with easy comparables) and rising carbon taxes point to a significant deceleration of the economy during the next few months

We continue to believe that long-term inflation expectations are still too low (tight labour markets due to demographic and de-globalisation aren’t taken into account yet by consensus). However, in the short term, inflation numbers should decline, especially good price inflation, where lower supply disruptions as well as the base effect will likely lead to lower headline numbers. Obviously, this scenario is currently challenged by the war in Eastern Europe, which has already led to substantial increase in commodity prices (especially energy) and if they are sustained will put renewed inflation pressure also on goods prices. In the past, wars tended to be inflationary.

The most likely scenarios, their likely probabilities and their effects on gold
To cover not only our base scenario as above, we elaborate also on the alternative scenarios including the consensus view, which is still very negative for gold given the anticipation of sharply rising real rates.

To summarize, most scenarios are very positive for gold; especially the base scenario and alternative scenario A have a probability of >80% and would result likely in a new all-time high of gold during 2022. Only the consensus scenario (with the lowest probability from our point of view) is somewhat negative for gold.

Gold breaking out and no-one cares
As can be seen below, gold has finally broken out of a 1½ year symmetrical triangle, a very constructive sign.
Source: Bloomberg

Given that this market breakout didn’t catch much attention and the fact that gold sentiment was in the doldrums, i.e. very negative for most of the last 1½ years, it is even more relevant. Disinterest in gold and gold miners is still very high, i.e. not only the technical outlook is very promising, but also it is supported from the behavioural finance point of view.

Gold miners: from un-loved and under-owned to become “loved” and part of portfolios again?
The interest in gold miners is even lower, but this could change dramatically during H1, 2022. From an asset class, which is currently in the bottom half of ROE and ROI momentum and price momentum, it could soon be the asset class with top quartile characteristics in FCF Yield, ROE and ROI momentum, valuation and growth perspectives. Price momentum will as a result likely change too, and gold miners could become the most favoured equities by the powerful quant investors, generalists and finally retail investors, which today play a prominent role in North America. The fact that gold miners discount less than USD 1’600 gold makes them also attractive relative to the bullion, especially given attractive and rising dividends yields and increased share-buy-back activity.

Investors’ perception towards gold and gold miners will likely soon change dramatically, as the most likely scenarios speak for more investment demand for gold and a resumption of the structural bull market, which started in late 2015. Given the strong fundamental gold demand, and the likely change to higher investment demand by investors, we expect gold to reach a new all-time high during 2022.

In a stable to rising gold price environment, gold miners will likely soon be the asset class with top quartile characteristics in FCF Yield, ROE and ROI momentum, valuation and growth perspectives. Price momentum will as a result likely change too. This should bode well and buying from quant investors, generalists and retail investors will likely lead to a massive revaluation of the deeply undervalued and underinvested theme.

We have seen a small increase in M&A activity during the last few months. As management teams get comfortable that today’s gold price environment is sustainable and due diligence is possible again (post Covid restrictions), we expect many more small bolt-on acquisitions. Stellar strong balance sheets and healthy FCF, as well as rather empty project pipelines, speak for such action. The Nestor Gold Fund is perfectly positioned for such an outcome. The well-above-average exposure to exploration and development companies is a key differentiating factor of the Nestor Gold Fund relative to active and passive peer products.

Walter Wehrli and Erich Meier, Konwave AG