Ned Naylor-Leyland, Merian Global Investors
“So, it is now time to recognise the obvious buying opportunity available for all gold and silver mining equities,” Ned Naylor-Leyland, manager of the Merian Gold and Silver Fund told FSA.
The unprecedented central bank monetary and government fiscal stimulus packages launched in response to the Covid-19 pandemic and resulting economic crisis points to low US interest rates and a weaker dollar.
These are conditions that support the gold price, according to Naylor-Leyland
“The price of gold is not driven by physical scarcity or abundance. Instead, the key determinant is the market’s expectations about the US dollar and the trajectory of real (that is, inflation-adjusted) interest rates,” he explained.
Yet, that’s not the only factor that excites Naylor-Leyland.
Gold mining companies have been side-lined by active investors for the past two decades, as their profit margins have been squeezed and sustainable earnings constrained.
“But, gold miners are now in the eye of a perfect storm,” he said.
The operating environment looks far better than it has in years, he argued. Margins are set to increase in a sustainable fashion, supported by falling oil prices and low local currency labour costs.
Meanwhile, long-only active equity investors who have ignored the sector for the past two decades have a clear lack of alternatives, according to Naylor-Leyland.
“Assuming current gold [about $1,700 an ounce] and silver [about $15 an ounce] spot prices, due to lower fixed and variable costs, earnings over the next couple of quarters should rise healthily. That is in stark contrast to expected declines in earnings in almost every other sector,” he said.
However, the physical gold market has been in turmoil in recent weeks.
“Basically, there is a lot of gold credit, but not enough physical gold to meet demand,” said Naylor-Leyland.
UK gold sovereigns and US gold eagles are unavailable as supply has dried up, while bullion houses are struggling to manage their credit books because of the scarcity of physical gold — which typically accounts for only 1% to 3% of daily turnover.
“In effect, it has been like a bank run,” explained Naylor-Leyland.
On the bright side, he thinks this is another compelling reason to gain exposure to mining stocks — rather than to the physical metal or its paper proxies.
About 80% of his $429m fund is invested in gold and silver mining companies, concentrated in Australia and the Americas, rather than Africa, central Asia and Russia where he believes governance standards are often weak.
Top bets include Evolution Mining, which recently acquired the Red Lake Mine in Ontario, Osisko Mining, which last year discovered a new gold-bearing zone at its Windfall Lake project in Quebec, and Silvercorp Metals, whose Ying silver mine in China is back to full production.
However, the fund’s performance has struggled recently.
Returns have been basically flat over the past three years, compared with 61.39% cumulative return by the FTSE Gold Mines index and 33.02% by the spot gold price (the fund’s two benchmarks) and the commodity sector average of 21.81%, according to FE Fundinfo.
The fund is down 13.21% so far this year (to 28 April), and although it bounced 14.73% in the last month, it still lags its benchmarks and peers.
A high allocation to silver miners means that the fund tends do best when the gold/silver ratio declines, as it did late last year. Relative performance has suffered this year as the ratio rose, according to Naylor-Leyland.
“We are living through very strange times, but it’s worth remembering that our fund was established for periods such as now,” he said.
Anecdotally there is interest among long-only funds to raise their exposure to gold and silver mining stocks, but many are reluctant to make strong calls in this unstable environment, according to Naylor-Leyland.
“That will change as they get used to the ‘new normal’,” he said.
Merian Gold and Silver Fund vs equity – commodity sector average and benchmark indices