Tactic one: flexible strategy
When Earth Resource Investment Group (ERIG) and Universal Investment launched the Earth Gold Fund UI, the premise was that gold fund outperformance requires a combination of solid technical analysis (to cover geological and mining engineering aspects) and a proven track record in company analysis and fund management.
The seven members of ERIG’s investment team are all geologists and mining engineers with many years of hands-on experience in global gold exploration and mining. Also, I am a mining engineer and my co-manager, Joachim Berlenbach, is a geologist; we have been in operations, fund analysis and management for many years.
Risk-on risk-off
In light of the current market situation, which sees risk-on phases alternate with risk-off, a fund manager needs to have great flexibility. One of the most important and successful strategies of our fund is the ability to change rapidly, within a few trading days, the average market cap of the invested companies. This flexibility, supported by the moderate fund size, allows for a focus on larger-cap companies in phases when the market has switched to risk-off; the fund then performs much the same as a large-cap fund, which manages an
asset base of several billion dollars.
However, in phases where the market has switched to risk-on, large-cap companies generally underperform the more attractively valued small and mid-cap sector, as we have seen in the risk-on phases of 2006-07 and 2009-10.
In phases of market corrections (such as 2012 when we were overweight large-cap companies), the Earth Gold Fund UI only slightly underperformed the FTSE Gold Mines Index in downward correction phases. In the year, the FTSE Gold Mines Index shed around 13%, whereas the Earth Gold Fund UI lost 11%.
In our opinion the equity market has bottomed out and investors have begun to move back into equities and especially gold equities. A return to assets perceived to be more risky bodes well for the mid and small-cap sectors. We aim to reduce our weighting of larger-cap companies to position ourselves for a new risk-on phase.
In this scenario it is important to separate the wheat from the chaff and to pick the best companies around. Our stock-picking expertise has also been demonstrated by the fact that of the six stocks subject to M&A activity over the past six months, five were in the ERIG portfolios (Andina Minerals, Galway Resources, La Mancha, Trelawney Resources and silver-copper producer Discovery Metals).
We believe these mergers are the start of a new phase of M&A activity. Clearly the space to be is in the small and mid-cap sectors, but picking the right stocks requires market and technical expertise. The moderate fund size and a team of experts make the Earth Gold Fund UI well suited to pick the best gold equities in the market.
The fund is a sub-fund of Irish-regulated Ucits umbrella fund Plurima, managed by European and Global Investments. Plurima acts as a feeder fund and buys units in Earth Gold Fund UI. Earth Gold UI itself is German-domiciled, managed by Universal Investments and advised by ERIG.
Tactic two: Fundamentals strategy
In the same year as BlackRock was founded, Julian Baring, the charismatic ‘gold guru’ of the City of London, launched the firm’s Gold and General Fund.
On the day of the launch – 7 April, 1988 – gold could be bought for $448/ounce. Nearly 25 years on, investors have enjoyed many a happy return courtesy of Baring’s creation and the management of the fund by the team that has become the natural resources team at BlackRock (via Mercury Asset Management and Merrill Lynch Investment Management).
It has been a cornerstone of our philosophy that precious metal equities can outperform their corresponding commodities. Precious metal producers can add value on top of any revenue increase that comes from a commodity price rise. Companies can grow production, improve the quality of production by lowering costs and pay dividends, for example; a gold bar, on the other hand, cannot pay its holder a distribution nor double its volume.
Production before exploration
Our investment philosophy leads us towards gold companies that typically have existing production but also the opportunity to increase that production through differentiating development or exploration projects. We tend to steer clear of pure exploration companies: for every success story, there are dozens if not hundreds of failures.
One of the privileges of our research process is going to see these assets. Every year my colleagues and I spend, between us, many weeks on the road, assessing mining operations and the people who run them.
This first-hand research is critical to our decision-making. Quality of asset, surrounding infrastructure, operational efficiency and local labour force relations can all make the difference between a portfolio winner and a drifter. But before you dust off your CV to apply for the jet-set thrill of mining portfolio management, a word of caution: the gold mining industry is having to go to riskier jurisdictions to access opportunities and so are we.
Geology is one thing; converting it into a mine that produces a hundred thousand ounces of gold a year is quite another. We place a lot of store by management quality and spend considerable time meeting the companies we invest in or may invest in. Determining what to pay for stocks and the construction of the portfolio is then the desk job.
We have built our own valuation tool, Verdict, which helps us understand the sensitivity of a gold company to various factors, its asset-by-asset potential and ultimately whether the stock appears cheap or expensive. The model’s output does not determine our decision-making, it aids it. It also does not build a portfolio – that is the intellectual challenge that my team and I go through every day, closely assisted by the tools and risk metrics we have at our disposal.
Gold is an exceptional asset class. Investors ask us whether we think gold is a commodity or a currency. The answer is both.
Gold has been used as a means of exchange and a status symbol for millennia. The primary driver of its strength over the past five years has been investment demand. Investors have flocked to gold in the face of financial market uncertainty, currency volatility and inflation fears.
Run of success
Gold is close to achieving its 12th consecutive year of gains, which leaves some questioning the sustainability of its strength. To those doubters we would put this question: do the same things that worried you two years ago still worry you today – inflation eroding the real value of your savings, currency debasement, the need to diversify your portfolio? If the answer is yes, then gold has a firm investment case.
The Gold and General Fund has provided many exciting and gratifying moments. It has also endured some frustrating ones and the performance of the gold equity sector against gold bullion over the past 18 months or so ranks high among them.
Gold equities have failed to share in gold’s strength as they have been held back by weak market sentiment and concerns over cost inflation and capital allocation. There has been a sector-wide de-rating. Not all asset bases and management teams are equal, however, and that de-rating has meant that we have been able to add to favoured companies at what in our view are discounted valuations.
Gold equities have underperformed the metal before but have always shown themselves capable of making up the lost ground.
