Gold: “Considerable upside potential amid market uncertainty and inflation concerns”
The DMS Charteris Gold and Precious Metals Fund was the best performing UK-based fund from more than 2,500 funds in 2019, returning 52%. That was the second time the fund clinched the top spot in the past four years having gained 134% in 2016.
The fund continues to perform. Over the past 12 months, the fund is up 53.4% despite the coronavirus crisis, with the fund recovering sharply (+32.7%) in April following the market declines in February and March. We believe the recovery will continue as investors seek safe havens amid the continued market uncertainty and protection from higher inflation caused by rapidly expanding central bank balance sheets – the Federal Reserve’s (Fed) balance sheet is now at a record high and counting.
In the following update, we explain the fund’s current strategy, its positioning and our long-term expectations during these uncertain times.
Performance of the DMS Charteris Gold and Precious Metals Fund
Our long-term view
We have been long-term structural bulls of gold and precious metals prices – a number of key issues have driven this bullish view. The most important is our view that eventually the cumulative expansion of money supply we have seen globally since the global financial crisis (GFC) and especially of the Fed’s balance sheet, will ultimately lead to higher inflation.
We believe Quantitative Easing (QE) is inflationary but that its impact on prices was masked in the aftermath of the GFC by a very significant reduction in the velocity of circulation of money. This was constrained by a combination of demographic factors (ageing populations in the developed world and retiring baby boomers) and weak credit growth – a product of regulatory pressure on banks to build capital combined with huge reparation costs throughout the ten years of the post crisis period. Absent these factors, QE would have led to higher inflation despite other disinflationary factors driving prices down such as globalisation.
Other factors that we believe will drive precious and non-precious metals prices higher are more demand focused typically driven by the accelerating shift to electric vehicles – an electric car uses four times more copper than an equivalent fossil fuel one – and growing central bank holdings of gold. The Central Bank of Russia was ahead of the pack in switching its US Treasury bonds into gold in 2018, taking over a year to complete the task due to the scale of the holdings. It still might have a bit more to do but we expect a lot of other central banks to follow suit.
Demand for jewellery has fallen sharply in the wake of the coronavirus crisis. However, it is worth highlighting that gold and silver prices traditionally underperform in the first half of the year as demand is fuelled by the wedding season in India that runs from June to September. Prices have held up despite the jewellery demand slump and we would expect this demand to pick up once the pandemic starts to abate.
Precious metals prices in the wake of the pandemic
The COVID-19 pandemic has resulted in the biggest global fiscal and monetary policy stimulus seen since the Second World War. It is becoming clearer by the day that central bank balance sheets are increasing at a rate that is unprecedented in order to offset the worst economic consequences of the crisis.
To put this stimulus into context, it may help to compare what is happening now with the period that followed the financial crisis. During the six years of QE1, 2 and 3 the Fed’s balance sheet grew by $4 trillion. So far during this crisis, the Fed’s balance sheet has expanded by $2trn over the last month and is forecast to grow by another $2trn throughout the rest of the summer.
When the Fed’s balance sheet expands, central banks and investors buy gold
This vast and rapid expansion in the monetary base, we believe, will reinforce the move to higher inflation which is something we think governments and central banks everywhere will quietly welcome. Consequently, we believe monetary authorities everywhere will tolerate higher inflation and certainly at levels above explicit targets for a period.
We also believe that some of the powerful disinflationary forces we have witnessed play out over the last 20 years or more are likely to go into reverse in the wake of the pandemic crisis. Shorter supply chains; a move to self-sufficiency in food production; vaccine production; and other key strategically important products could all lead to higher prices – in other words a partial reversal of the last 20 years of globalisation. We also expect key public sector workers throughout the developed world to see inflationary wage increases. All of this inflationary pressure will be bullish for all real asset inflation hedges but especially so for gold and other precious metals prices and of course for equities exposed to these assets.
Negative real interest rates
Another factor behind our bullish view for gold and precious metals are the continued low nominal interest rates (and negative real rates) on bonds and cash savings. Gold tends to flourish when “real” inflation adjusted interest rates/Government bond yields are low or negative. At present other so-called inflation proof assets such as UK Index Linked Gilts are on record negative real yields of up to minus 2.2%. In contrast, the DMS Charteris Gold and Precious Metals Fund has a positive dividend yield of around 1%.
So far this year the large cap precious metal stocks have led the way with blue chips such as Barrick Gold and Newmont Corporation delivering strong returns. These performances have been buoyed by the large institutions buying the largest index constituents. The switch from outperforming large blue chips to midcaps has yet to take place and the DMS Charteris Gold and Precious Metals Fund is positioned for when it does.
The fund has an underweight position in the larger names because we believe we can find the most value towards mid-caps rather than the big gold miners. Blue chips tend to have declining production profiles, while midcaps are often takeover targets. Midcap gold mining shares are still cheap relative to gold itself, so investors don’t have to worry about paying excessive valuations to increase their exposure to the Fund for the expected returns ahead. Furthermore, the miners are, perhaps, the only sector where we can expect dividends to increase this year as revenue is going up and costs down.
Despite recent gains, gold and other precious metals offer considerable further upside potential as gold remains in a primary 20-year bull market that we expect to peak in the next 12 to 18 months, potentially with a blow-out top in prices. It is worth remembering that gold prices surged by 40% in the final nine months during the last major cycle of 1960-80.
These expected gains are likely to be driven by continuing strong investment demand as interest rates stay low or move to negative, which we expect eventually to stoke higher inflation. Precious metals have long been seen as one of the best hedges against inflation. Within the precious metals complex, silver’s valuation versus gold is at an all-time low. We have a long -held view that silver outperforms gold in bull markets. In short, we believe that if you are bullish on gold, an investor should have a decent exposure in a portfolio to silver. We believe that silver will soon start to dramatically outperform gold. The DMS Charteris Gold and Precious Metals Fund has the highest exposure to silver, at 50% versus gold at 50%, amongst the peer group.
There are many pointers that suggest the recovery we have seen in the Fund in the past month can continue. The foundations of our strategy are based on my strongly held view on higher inflation. If this plays out as we believe it will, it will be bullish for all real asset inflation hedges but especially so for gold and other precious metals prices.
Past performance should not be as guide to future performance. All performance information is based on the Institutional Accumulation class unless stated otherwise. The value of this investment and the income from it can go down as well as up, it may be affected by exchange rate variations, and you may not get back the amount invested.
The views expressed in this article represent the views of the author at the time of preparation and should not be interpreted as investment advice.