Gold has been one of the best performing asset classes during the coronavirus crisis and could have further to run, according to Franklin Templeton Investments’ Steve Land. And such a continuous ramp up in gold prices will have clear knock-on benefits for gold miners.
Performance of Bloomberg Gold sub index YTD
Source: FE Analytics
Land, manager of the offshore $439.2m Franklin Gold and Precious Metals fund, said the popularity of gold has been caused by “investors respond[ing] to a weaker US dollar, record-low US real yields and intensifying US-China geopolitical tensions”.
He added: “The unprecedented amounts of stimulus and other relief funding used globally to prop up economies hobbled by the Covid-19 pandemic, including rock-bottom interest rates, have also continued to be a boon for the price of gold.”
And Land said that the yellow metal could continue rising past its August high for several reasons.
These include the increased levels of market volatility and uncertainty caused by the impact of the coronavirus as the final months of 2020 approach.
Such “mounting concerns” will benefit gold, said Land, “as investors seek perceived safe-haven assets”.
The fact that gold is traditionally uncorrelated with other asset classes supports “increased interest in owning it as a portfolio diversification tool in uncertain markets”, the fund manager noted.
As such, Land said the current backdrop for gold presents an opportunity for precious metals miners to make their businesses stronger and “redefine themselves as a vital part of a diversified investment portfolio”.
Below, the manager highlights three opportunities for gold miners to become stronger businesses and, therefore, more attractive investments for generalist investors.
Capitalise on higher gold prices to grow profitability
One characteristic of gold mining stocks is that over the past few years they haven’t rallied “in lockstep”, with gold prices, according to Land.
He said many miners struggled to create free cash flow when gold was trading at $1,250 per ounce because it was around a breakeven level.
“Mining costs tend to be relatively fixed, so higher gold prices can flow straight to the bottom line,” Land said. “In our view, the recent rally in gold prices should provide a significant lift in cash flow across the industry.”
A combination of a rising gold price and falling input pressure costs – such as lower fuel prices and low labour inflation – means that margin expansion in the industry is pushing gold equities to more compelling levels, said the manager.
“Even with the price of gold moving to all-time highs, most mining companies have maintained a focus on improving the cost structure of their operations, debt repayment and asset rationalisation, which we believe should result in better businesses and improved stock performance potential going forward,” he explained.
“In our view, management teams look increasingly focused on turning higher gold prices into free cash flow that can be returned to shareholders via dividends or reinvested in high-return projects.”
Leverage increased scale to improve the business
The Franklin Templeton manager said gold miners may also be able to take advantage of increased scale to improve their businesses, possibly through merger & acquisition activity.
“Although the pace of acquisitions has been slowed in the near term due to travel restrictions and other short-term business impairments associated with the Covid-19 pandemic, in the longer term, we believe companies that operate multiple mines should be able to make better capital allocation decisions,” said Land.
“In our view, these companies will likely deploy capital toward only their best projects and achieve higher market multiples as a result.”
A shortage of skilled, experienced workers in the mining industry will also likely drive M&A activity, with larger, well-run companies able to hire and retain top talent, said Land.
Greater business consolidation will also ultimately help diversify generalist investors’ portfolio risk, the manager added.
“These investors may not be interested in holding several gold companies in a portfolio or taking on the increased risk associated with owning a single-asset or development-stage miner,” he explained.
“Additionally, in a world dominated by index funds, we believe there are tangible advantages to having a larger market capitalisation and better trading liquidity.”
Create new ways for consumers to engage with gold
Finally, while gold’s role in markets has come a long way over the years, more needs to be done to support the physical ownership of gold, according to Lan, which would create new sources of demand going forward.
While central banks have become the most significant buyers of the yellow metal in recent years, the development of physical gold-backed exchange traded funds (ETFs) have helped expand market participation.
“These ETFs have attracted large new pools of capital that previously wouldn’t have invested in gold and helped to create greater efficiency in the gold price-discovery mechanism,” he said. “ETF purchases have been one of the main sources of physical gold demand over the past six months.”
But, Land added that most of the world’s gold, and most of what is produced each year, is held in jewellery, small-investor coins, or bars.
And while there have been some advancements in 3D printing and materials science “little of this knowledge seems to have been applied to the gold industry outside of sophisticated electronics”, said Land said hardly any of this has translated to the gold industry as a whole.
“Most of the gold items sold today are almost identical to those made 100 years ago,” he added. “We believe more should be done to support the physical ownership of gold; new product introductions could represent a solid source of demand growth looking forward.”
Performance of fund vs benchmark over 3yrs
Source: FE Analytics
Land has been a manager on the Franklin Gold and Precious Metals fund alongside Frederick Fromm since launch in April 2010. Over the past three years, it has made a total return of 64.82 per cent, compared with a gain of 81.23 per cent for the FTSE Gold Mines benchmark. It has an ongoing charges figure (OCF) of 1.83 per cent.