Gold warning bells chime
PORTFOLIO POINT: Investors are prospecting for yield in assets with high return potential, and goldminers and physical gold bullion could be losing their investment shine.
Gold is in trouble. For the first time in a decade the case for owning physical gold is weakening, and the case for investing in goldmining companies is collapsing.
That was the most significant message from the annual Mines and Money conference held in London last week.
Once the star of the annual event, gold was this year singled out for unexpected criticism, mainly because of the failure of goldmining companies to capitalise on the record price for the metal, but also because other commodities were becoming more appealing.
The sharpest and most widely reported comments about gold came from Evy Hambro, managing director and joint chief investment officer of the natural resources group at one of the world’s biggest fund management companies, BlackRock.
With his associate, and manager of the BlackRock World Mining Fund, Catherine Raw, Hambro called on goldminers to clean up their reporting standards so investors can more easily compare mining production costs, and therefore have a more transparent view of each company’s financial performance.
“We want gold industry leaders to come up with an industry standard that allows them to talk to stakeholders on a level playing field so you can see who’s doing a good job,” Hambro said.
But, hidden in the criticism of opaque reporting of production costs that have destroyed the benefits of the high gold price for investors was an even more powerful message – the need for goldmining companies to start paying higher dividends in order to compete with other categories of investment that generate much higher yields than goldminers.
In effect, Hambro was asking that gold companies join the worldwide trend towards investing for yield rather than capital gain, a game that physical gold cannot play as it does not pay a dividend at all.
The criticism of the poor dividend-paying record of goldminers was echoed by other speakers at the remarkably well-attended conference, with more than 3000 delegates (10% more than last year) making their way to a chilly convention centre in Islington.
Demanding that gold companies boost their industry-wide average of paying only 25% of their earnings as dividends, compared with 45% for oil stocks, and even higher for some categories of industrial companies, was an example of the challenges facing goldminers.
Perhaps even more worrying for gold was the optimistic tone of the conference that was best expressed by Anthony Desir, principal of the SAMI funds management business.
“This is the last of the bad years,” Desir said of 2012. “I base that forecast on three points of convergence. The US presidential election is over; Europe’s financial problems are settled, if not resolved; and China is recovering.”
“I am so convinced that 2013 will be a much better year that I would bet the ranch on it.”
Desir was easily the most outspoken optimist at the conference, but there was unquestionably a more positive feeling at the event despite the poor attendance by bankers and stockbrokers who have been hit hard by industry-wide retrenchments.
Optimism of a sort not evident in the past five years could become the biggest enemy of gold, arguably the world’s ultimate currency and ultimate safe harbour.
Just as low-yield government bonds are starting to lose their appeal in favour of higher-yielding equities, so does gold risk being exposed as an investment with:
- No yield if held in its physical form, or
- Minimal yield if held through low-dividend paying mining company shares.
While gold retains a role in all balanced portfolios because it is in an investment class of its own and deserves a priority place, recent events are rubbing the gloss of gold’s appeal. This means that now might be time to trim exposure in case a recent weakening becomes a sharp correction.
If that happens, high-cost goldmining companies risk being massacred in a stampede for the exits because they fail two tests – low profits and even lower dividends, and production of a commodity which performs best in troubled times.
Also in the firing line are many of the estimated 500 small Australian mining companies with some gold interests but with limited cash reserves to fund ongoing exploration, let alone pay for the development of a mine.
The advice of seasoned Australian gold company director, Tim Goyder, is that the small end of the goldmining industry is heading for a major shake-up.
“The industry is facing demands that it behaves more like a conventional business, focussing on the generation of profits and not just the production of ounces (of gold),” Goyder said at the London event.
Another well-known Australian face in the London crowd was that of stockbroker Hugh Wallace-Smith, who said there was likely to be a bout of merger and acquisition activity among small miners next year – not to achieve growth but to save costs and survive in some form.
It is, obviously, courageous to assume that the world really is starting to emerge from five years of financial crisis. There have been too many false starts for that to be an unquestioned event.
But, the mood at London’s premier mining conference sat very comfortably with the predictions of Eureka Report’s own Adam Carr, who last week reinforced his argument that 2013 will be a much better year than is widely expected in a report headed: “Busting the bust myth”, in which he noted that “there are still no signs of the impending mining investment bust”.
Carr’s enthusiasm was mirrored two days later by Percy Allan, who claimed that global economic conditions “combined with last trends, indicate that we could be on the cusp of a secular bull market”.
Encouraging as it is to be reading positive forecasts of the year ahead, gold is an asset class that is starting to pay a price for the improving outlook.
Stronger economic conditions, rising profits and higher dividends from traditional industrial activity, including the production of industrial metals such as copper, zinc and nickel, is the antithesis of what’s required to drive the gold sector.
The recent retreat in the gold price below the US$1700 an ounce mark could be an early warning that gold’s bull market has peaked and a period of decline lies ahead.
For true believers in gold as an essential component of an investment portfolio, including me, the year ahead could a testing time – not that I’ll be selling the last of the physical gold in my family’s pension fund.
It was acquired for the long term and it will ride out what looks to be an emerging downward slide because it is an asset beyond the reach of governments and their habit of debasing their currencies with excess creation of paper money. It is an anchor for troubled times in the portfolio.
But no matter how convincing the argument is for holding gold as a long-term investment, the danger in the short term is that a bear market appears to be developing for gold, especially high-cost miners who have been exposed as having a weak business model, a poor dividend record, and now face the pincer squeeze of a falling price for their only product.