Matthew McLennan owns gold bullion because the future—now more than ever—is uncertain.
“If we knew what the future held, we’d probably have either all equities or all gold. But to recognize the limits of your knowledge is an important reason to own gold,” says McLennan, co-portfolio manager of the $1.2 billion First Eagle Gold fund (SGGDX).
As the novel coronavirus sweeps across the globe, it is creating havoc on markets and significantly damaging the U.S. and global economies—generating a level of uncertainty not seen since the 2008-09 financial crisis.
Only gold and U.S. Treasuries are up year to date, although gold slid earlier in March as some holders sold it to raise cash. However, with the Federal Reserve and other central banks slashing interest rates and taking other steps to support markets, the yellow metal surged to levels not seen since early 2013 on Tuesday.
The monetary policy response and Congress’ $2 trillion stimulus plan “are the best thing that can happen to gold in the long-term,” co-portfolio manager Thomas Kertsos says. Time will tell if stimulus measures are worth the potential risks of high sovereign debt levels, he adds: “It’s very hard to imagine that we are going to get out of this without inflationary or deflationary consequences, which opens risks and opportunities for the absolute and real price of gold going forward.”
The co-managers say times like these make the case to own gold strategically as a potential hedge and not as a bet for higher prices. First Eagle Gold’s 18.5% holding in physical gold is part of the reason why, year to date, the fund ranks in the top 2% in the equity precious-metals category, according to Morningstar—and is also beating its index, MSCI World/Metals & Mining, by a wide margin. Its average annual return has outperformed its peers on a one-, 3-, 5-, 10-, and 15-year basis.
McLennan, 50, and Kertsos, 39, co-manage the five-star, silver-rated fund, which has average fees for its category and carries a 5% load.
McLennan joined First Eagle in 2008 to lead the firm’s global value team, coming from Goldman Sachs Asset Management. He took on the gold fund in 2013. Kertsos joined First Eagle in 2014 as a research analyst and in 2016 became co-portfolio manager. He previously was an associate analyst covering precious metals and mining at Fidelity Management and Research.
Physical gold is the fund’s top holding, setting it apart from other gold mutual funds. Also unique is the managers’ silver bullion position, a top-six holding. Silver bullion is influenced by the same drivers as gold but also acts as a diversifier since it has industrial uses.
Kertsos says physical gold and silver combined typically make up less than 25% of the fund. One benefit of holding physical metal versus mining stocks is that the commodity won’t be devalued because of poor corporate management. The fund’s metal is stored in two highly secured vaults in allocated bars, with a third location available as a contingency plan.
Gold also has an outsize influence at the fund’s parent company, First Eagle Investment Management—five of its seven mutual funds have some sort of gold-based investment holding. Companywide, First Eagle holds more than $12.5 billion in gold-based investments, making the firm one of the most significant institutional investors in gold-related assets.
Because McLennan and Kertsos view gold as a potential hedge and take a long-term view, they are also patient buyers of gold securities. There is a lot that goes into valuing mining companies, both on the management side and technical side. They consider several factors before buying equities because they want to own resilient companies. “We only really want to move bullion out of the vault to gold in the dirt via equities, if you will, if we have a margin of safety in price,” McLennan says.
The pair reviews a company’s capital, operational, and geopolitical risks, and approaches potential investments with the idea of what can go wrong. “It’s a very tough business, and it’s extremely important to focus on downside scenarios,” Kertsos says.
They look for companies where management has strong capital discipline and focuses on free-cash-flow generation. The strongest management teams have a bottom-up focus, understanding their mines’ geology in granular detail, and can increase gold reserves over the long term without sacrificing employee safety.
To estimate a company’s aggregate net asset value, they use the spot gold price to value the cash flow generated on a mine-by-mine basis over the mine’s life. There is also a subjective element, too, as they have to assess how likely the company can get the gold out of the ground at the spot price, so they review mine quality and location as well as the management team’s record of delivering on promises.
With the fund’s focus on quality, it isn’t surprising to see the most senior gold-mining companies in the portfolio, with Newmont (NEM) and Barrick Gold (GOLD) as their top-two equity holdings. Kertsos says both firms have the best management teams in the industry and own some of the best assets anywhere, two critical components for resilience. Both companies have strong free cash flow, each generating more than $1 billion annually.
Kertsos says some countries like Peru are shutting down mines to halt the spread of Covid-19, but it’s hard to tell what the impact on production will be, since it’s still early days in the fight against the virus. However, a lull in mining output likely won’t affect gold prices because there is plentiful aboveground supply and prices show gold is acting like a currency, not a commodity.
Kertsos says they are looking now to add to long-term positions of companies they already own or would like to own, while keeping their quantitative criteria in place. “This is exactly the time we see opportunities as the valuations become depressed,” he says.
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