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NESTOR Gold - Quarterly Report 4/2020

As of December 31st, 2020, gold bullion closed at US$ 1,898.36/oz., an increase of 0.7% QoQ. For the year 2020, gold increased by 25.1% in USD.

Review
As of December 31st, 2020, gold bullion closed at US$ 1,898.36/oz., an increase of 0.7% QoQ. For the year 2020, gold increased by 25.1% in USD. The Philadelphia Stock Exchange Gold and Silver Index and the Nestor Gold Fund (share class B) increased by 2.8% in Q4, 2020 (USD). For the year 2020, the index increased by 37,3% (USD), while the Nestor Gold Fund gained 52,7%. The fund significantly beat physical gold, its benchmark and the peer group during 2020. This is thanks to successful stock picking within the small, mid and large cap producers and its exposure to gold and silver exploration and development companies.

While the fund continued its disciplined value approach and added to deep value names in Q4, it also benefited from the exposure to the explorer/developer segment, which proved very resilient and contributed positively, while the very liquid large caps were sold by tactical investors.

Among positive vaccine results and rising economic optimism, gold continued its consolidation until the end of November. This led to outflows in gold ETFs, which were the key drivers of the correction in gold. Physical demand in China and India started to recover after a disappointing year. Gold miners published generally very good Q3 results and many companies announced further dividend hikes. Despite this year’s rise, gold miners are still trading at low valuation. Operating leverage and continued industry discipline bode well for the next quarters and we expect gold miners to continue to outperform physical gold in a stable or rising gold price environment.

Why has the next uptrend just started?
During the last three months, we have seen many tactical investors (like banks, hedge funds, etc.) exiting or sharply reducing their gold allocation. The main reasons given were rising economic optimism and the start of a new risk-on-trade. While we share the view that 2021 will likely have an economic recovery, we don’t share the view that this is negative for gold. In reality, gold has had historically a significantly better performance during economic expansion than during recessions! While fast money sold or reduced their gold holdings (seen in ETFs outflows), gold had a very healthy three months’ correction and sentiment retreated to very pessimistic levels; a powerful and reliable contrarian buy signal!

What are the key reasons why gold has just recently started its next uptrend? First of all, the government reactions (fiscal and monetary) to the Covid-19 pandemic are resulting in a massive further increase in debt and monetary aggregates, two very bullish drivers of precious metals’ prices. This results in a decrease in the confidence in fiat money, sharply reduces the probability of a monetary or interest rate normalization and is increasing inflation expectations.

Therefore, we are convinced that the following key reasons will support the gold price development in 2021:
•    Real rates to decrease further, as inflation expectations are starting to rise
•    Asset allocation shifts towards real assets like gold and other assets, which have a low correlation to equities
•    Confidence in the monetary policy to decrease further

All these will lead to a sustained high level of investor demand in gold and as the selling of fast money is showing more and more signs of ending, the long-term uptrend in gold has likely resumed in early December. Especially the next few months are looking very interesting given we are heading simultaneously into Chinese New Year (about 25% of global annual gold demand) and  the Indian wedding season, as the Covid-19 situation has sharply improved in India. Unlike during most of 2020, when jewellery and gold demand out of the two most important markets were very weak, we are heading now into the most promising season, helped by recovering economics in China and India.

Why does the real opportunity lie within the Nestor Gold Fund?
With the promising outlook for gold, we have to take a closer look at the gold miners. The North American gold producers do currently discount a gold price of less than USD 1’700. Therefore the gold stocks can easily increase by 20-30% without any further gold price change.

What could trigger such a rerating? The gold mining industry will be debt-free by January 2021 and has a higher free cash flow yield than most other equity sectors. Many companies will therefore increase the dividends further, to levels which generalist investors will struggle to ignore any more. Also eye-catching is the fact that recent (Q3, 2020) free cash flow was double the quarterly peak of the last 20 years, while gold mining indices would still need to rise more than 70% to reach the highs of 2011!

In our recent video calls with management teams, it became clear that, besides continuing to focus on higher free cash flows and rewarding investors with further dividend hikes, the large and intermediate producers will start addressing the often rather empty project pipeline. Given its tilt to exploration/development companies, the Nestor Gold Fund is very well positioned to benefit from the starting M&A wave. While the fund had exposure to nearly all takeovers of public companies in 2020, we expect a significantly higher positive contribution out of takeover to the fund in 2021.

While investing in gold miners and the Nestor Gold Fund has often been a volatile and challenging experience, an investor should not underestimate what kinds of returns have historically been achieved during the environments we currently face. In reality, the Konwave precious metal funds returned about 50% per year (and outperformed the index tracker by 16% per year!) during the bull market periods in the last 20 years. While “only” about 2/3 of these 20 years were bull market periods, there are currently no indications that the current bull market will 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.

Why is now an attractive time to buy/add the Nestor Gold Fund?
As mentioned in the second section of this report, fast money has already excited gold again. As a matter of fact, based on the sentiment indicators (Chart below) gold has become a contrarian investment again!

 
Sources: Ned Davis, Konwave AG

Besides the again bearish sentiment against gold, we are also observing that, while fast money sold their gold allocation, there has been some small buying in gold mining ETFs and our funds over the last three months.

This confirms our view that more strategically oriented investors are starting to realize the huge opportunities gold miners do represent, a very promising sign for 2021.

Conclusion
After a very eventful 2020, investors in the Nestor Gold Fund were proved right with their view and handsomely rewarded. As the gold miners market started to broaden towards the cheaper and more attractive smaller companies, the fund was able to make a meaningful difference, providing investors with about 15% more return, respectively in EUR 2,2 to 3 times the return of the most well-known gold miners ETF.

During the autumn, many tactical investors (like banks, hedge funds, etc.) have exited or sharply reduced their gold allocation. This makes us optimistic that the next major uptrend started in early December, helped by rising demand from China and India. We are convinced that the key reason for elevated investment demand will remain in force during 2021, which should bode well for gold miners.

There is also rising evidence that, besides continuous focus on higher free cash flows and rewarding investors with further dividend hikes, the large and intermediate producers will start addressing the often rather empty project pipeline. Given its tilt to exploration/development companies, the Nestor Gold Fund is very well positioned to benefit from the starting M&A wave.  

We would like to thank you for your loyalty during the volatile 2020 and wish you a successful and happy New Year.

Walter Wehrli and Erich Meier, Konwave AG