“Someone once told me that you were not wealthy unless you owned your weight in gold” -said the client. I had not heard this argument before. Regardless, the implied sum sounded substantial. I started to calculate in my head just how many dollars’ worth of gold she was telling me she was considering to buy (somewhere around 3 million USD). Would we have to liquidate all of her investment portfolio to accomplish this goal? Was this a worthwhile goal? Was buying gold even a good idea? This was sometime in 2012. Gold had been selling off from its highs as the world continued to recover from the great financial crisis. Would it have another run higher? I thought not. Now how could I tell her politely that I thought that she would be better off staying invested in productive and income generating assets such as stocks and bonds rather than something shiny that was dug out of the ground just so that someone could buy it, and then pay to store it in the ground again? Or rather, how could I tell this to the private banker and hope that nothing was lost in translation?
But let’s return to the calculation of how much your weight in gold would be worth. The standard measurement of gold is in troy ounces. There are 32.15 troy ounces in a kilo of gold. At current prices, a kilo of gold would sell for around 64,000 USD or 54,000 euro. Please feel free to do the calculation of how much gold you would have to buy if you have not done so already. Perhaps this would be a great formula to add to those Instagram weight loss program advertisements as an extra incentive to lose weight: “The less you weigh, the less gold you have to buy to be considered wealthy! Every kilo counts!” Unfortunately, the problem with gold is that you can’t use gold to buy more gold. It doesn’t compound. You are simply reliant on someone, at some point in the future paying more for your gold in another currency or asset. That is the definition of speculation.
This summer, gold has traded at all-time nominal highs versus every world currency, but the past eight years have not been particularly kind to gold holders relative to the performance of high quality stocks and bonds. Lately that has changed, and gold’s record rally has been drawing more and more media coverage.
In early August, investors were shocked by the disclosure that Warren Buffett’s Berkshire Hathaway had purchased 20,918,701 shares of Canadian mining company Barrick Gold in their second quarter filings (worth around $564 million). Buffett had often derided gold. His piece de resistance against buying gold was his 2011 shareholder letter that touted the productive capacity of American farmland and industry versus a lump of something shiny that created nothing. I remember paraphrasing Buffett’s argument when dissuading my client from buying her weight in gold. Buffett turned out to be very right. Gold prices peaked in 2011 and only took out their previous highs a couple of months ago.
And yet nine years later here he is – Warren Buffett himself – buying a Canadian gold miner?! What is going on Warren? Did you have a couple too many Diet Cokes? (Warren drinks several Diet Cokes a day)
On a relative basis, Berkshire Hathaway’s holding of Barrick Gold is very small in comparison to his larger holdings. For example, Berkshire Hathaway’s holding of Apple Inc. shares is worth over 200x more that their holding of Barrick shares. Also, by buying a gold miner he is not simply buying gold, but a producer of gold, and the future cash flows related to their gold production. Maybe he likes that historically gold does very well in environments – such as the current one – where there are negative real rates (interest rates minus inflation). Possibly he is intrigued by Barrick’s ability to raise the valuation of their gold reserves based on higher gold prices. Or their ability to buy additional reserves through accretive M&A transactions powered by their low borrowing costs and a solid balance sheet.
However modest his position in Barrick Gold, what Buffett has done is given his tacit approval that gold miners can be bought. This has potentially massive implications for institutional investors around the globe. I meet with almost one hundred – mostly European – fund managers a year. Over the past six years I have never heard a single manager pitch their gold miner fund or talk about the virtues of an individual gold mining stock. None. Having spent the earlier part of my career as an institutional equity trader in Canada, and having bought and sold many gold mining shares, I have often thought of what would it take for Europeans to take an interest in gold mining companies. I had never considered that it would be Warren Buffett that gave the green light.
Five months on from the depths of the Covid-19 sell off the S&P 500 index just hit new highs. Many investors are baffled by the speed and strength of the stock market’s recovery, but there is little doubt of the massive role played by the US Federal Reserve’s move to expand its balance sheet and its positive effect on financial asset prices. The sums are staggering.
Since the summer of 2008 until mid-August of 2020, the Bank of Japan, the European Central Bank and the US Federal Reserve have added the equivalent total of almost 17 trillion USD to their balance sheets. China’s Central Bank has added another $2 trillion. There are approximately 200,000 tons of gold that have been mined in the history of the earth, of which two thirds have been mined since 1950. Each ton has 32,151 troy ounces. At the current value $2000 per Troy ounce, the total value of this gold is 12.86 trillion USD. So yes, the world’s major central banks have added roughly 1.5x the value of all of the gold in the world to their balance sheets since the start of the Great Financial Crisis. The core idea of central banks expanding their balance sheets by buying bonds is that it frees up money to be deployed elsewhere in search of greater profits
This sort of ‘trickle down effect’ is especially pronounced in commodity markets when the underlying commodity price is rising, as has been the case with gold. This dynamic has the possibility of being even more pronounced if the sector is under owned by institutional investors. But the fact that there is only one gold company – Newmont Gold – in the S&P 500 index at a 0.2% allocation means that passive investors also own practically no gold equity exposure.
Here is how gold miners stack up against other major assets:
Big money investors begin by buying entry positions into larger, liquid commodity producers. This gives them the ability to back out if their thesis is compromised and minimizes their impact of driving up the price through their buying program. The sellers are then free to deploy the proceeds of their sales farther down the food chain and mid-tier producers begin to perform. The last ones to move are the smaller, more speculative plays, but their price appreciation tends to be the most stunning of all.
While I fully admit that owning your weight in gold sounds pretty impressive, what will be far more impressive if the current gold rally continues its current momentum will be to buy yet to be mined gold reserves at a fraction of the current price of gold. It might not be realistic for most investors to own their weight in gold, but there are some prospective miners whose ounces in the ground are still priced at very modest valuations. And with the past ten years of lower gold prices, there has been a reduction of exploration activity and new unmined gold reserves, making the proven reserves of these miners that much more attractive:
Add this dynamic to the amount of money being created by central banks and the case for gold miners gets even more interesting.
Large miners like Barrick have slashed exploration costs and divested non-core assets in order to repair their balance sheets. Mergers and acquisitions have begun to gather pace, but if past cycles are any indication, the action is just getting started.
Buffett will never buy a junior gold miner, but the more money flows into the major miners like Barrick, the more they will be motivated to ramp up production and replace reserves. This will be extremely bullish for high potential junior miners. Smaller gold mining companies tend to be very volatile as they have massive sensitivity to the price of gold, but the winners will be spectacular. And if anyone has ever liked buying future dollars for pennies, its good ol’ Warren…
(This article appeared in the September 2020 edition of Forbes Latvia)