The pullback in gold and gold miners post the Covid-19 market shock provides significant opportunities for active managers who can select individual companies that present the most attractive relative value. 
One of gold’s primary investment attributes is as a store of value in uncertain times. Gold is supposed to provide an insurance policy within a portfolio, to protect against market crashes. When the market falls, gold should rally and offset the losses elsewhere in the portfolio. This rule generally holds true until we see a liquidity crunch on the scale of early March, due to virus concerns. Precious metal equities have shown little immunity to a synchronised sell-off of this scale. This has exceeded the selloff during the global financial crisis for its pace and extent. Unfortunately, during these moves everything correlates, as institutional investors scramble to sell relative winners to cover losses elsewhere and address their margin rather than consider true value.
Let’s put this into perspective. Gold initially sold off $200 from its February high of $1,673/oz, but has since recovered to $1,653/oz as of 7 April, a 9 per cent gain year-to-date (YTD). Over that period, the New York Gold Bugs index has lost 12.8 per cent. When we look at gold in producer currencies such as Canadian and Australian dollars, or the Mexican peso, gold has seen much great gains. Gold has also gained 17.4 per cent YTD to in sterling. This is important as producer’s costs are dominated by the country in which they produce, thus their margins will benefit as their costs fall more than their revenues.
Gold performance YTD, normalised to 100 (Orange = Gold in USD, Blue = Australian Dollar, Red = Mexican Peso, Pink = GBP)
The initial pace of the market selloff is what was truly remarkable. The risks of herd mentality are elevated in a market that is overly dominated by passive funds and exchange-traded funds (ETFs) and it looks like those fears came to fruition with the most extreme selling pressure coming from positions held in major ETFs. This provides significant opportunities for active managers who can select individual companies that present the most attractive relative value in a sector that has overly sold off.
Looking forward it is important to remember the drivers of gold. Gold is a currency more than a commodity, although it carries zero government credit risk and thus typically performs well in times of low interest rates and stimulus. This was seen in the performance of gold during the global financial crisis. in late 2008, gold fell to $720/oz, before rallying to $1,900/oz in September 2011. The actions we have seen in the last few weeks include unprecedented levels of government support that exceed even those seen during the global financial crisis. Europe has foregone any budget constraints to raise borrowing to fund large stimulus plans, whilst the US has likewise announced significant monetary and fiscal stimulus. The fall in the oil price is a further beneficiary to miners, with open-pit miners benefiting the most due to higher usage. Although in some cases the full benefit won’t pass through fully to a miner’s costs, as prices can be regulated by the countries in which they operate.
An outstanding question is the ability to operate under the backdrop of Covid-19. We have already seen the temporary closure of mining in South Africa, Chile and Peru, amongst others, due to attempts to reduce the movement of people. We are likely to see further projects forced to wind down in the coming weeks. In general, the miners have strong balance sheets that are able to weather a period of production outage, while any fall in production should support commodity pricing.
While there are still many unknowns, the weakness of the stocks appears unjustified by the fundamentals and strong gold pricing. The ability to operate is a risk, but one that looks manageable for now. In the longer-term fundamentals for precious metals look better than ever as we see the largest transfer of corporate risk on to government balance sheets that we will hopefully ever see in our generation.
Rob Crayfourd and Keith Watson are portfolio managers of CQS New City’s Golden Prospect Precious Metals trust. The views expressed above are their own and should not be taken as investment advice.