Imaru Casanova
Deputy Portfolio Manager and Senior Gold Analyst
VanEck
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View from the Top

Gold - a Safe Haven

By Paloma Duran | Fri, 06/18/2021 - 15:21

Q: What is VanEck’s role in the mining industry?

A: VanEck, through both its active and passive investments, is one of the largest shareholders in the gold mining industry.  We have passive investments through our gold miners ETFs, GDX and GDXJ, which gives us a large ownership share in many gold mining companies. We also manage a mutual fund, of which I am the deputy portfolio manager. That portfolio is an active strategy with holdings in about 45-50 gold mining companies.

 

Q: What opportunities is VanEck providing to industries such as mining and how are your investment strategies different from traditional approaches?

Several factors differentiate us. We have a bottoms-up approach to our investment process, which means that we are modeling the companies in our universe in detail, mine by mine, conducting our own evaluation and creating our own operating and financial models of these companies. We then analyze the results to give us an idea of where these companies stand.

We are looking for value opportunities, so if a company appears to be trading at a discount to its peers, we investigate it.  Sometimes, the discount is justified. Other times, the company is simply being undervalued by the market, presenting an opportunity. When selecting an investment opportunity, we determine that the company is of high quality and that identified risks are manageable.

We start with a very fundamental evaluation of the company and then we overlay other factors, such as the strength of the management team, quality of the asset, technical risk of the project and mining jurisdiction. Considering these factors, we make an investment decision and decide if the company should have a place in our portfolio and to what extent. 

 

Q: Do you consider Mexico to be an attractive investment destination?

A: Mexico is a prominent mining jurisdiction with a great deal of geological potential. Historically, we have had a sizeable exposure to Mexico. However, that exposure has been reduced. In 2018, before the presidential election, we lowered our exposure in Mexico. We reduced the weight of those companies with assets in Mexico to account for what we saw as increased risk in the country. Previously, our exposure was around 14 percent for Mexico. Today, it has dropped to around 5 percent. Those risks that we saw coming have become real threats to the mining industry in Mexico. While the reduction of exposure has also been due to company-specific issues, I would attribute most of the drop in our exposure to Mexico to the current risks.

 

Q: What are the major investment risks in Mexico?

A: The uncertainty comes from nationalistic trends.  Recently, for example, a halt in the issuance of new mining permits highlights these risks. Given the current administration, there is an elevated risk that the operational terms could change for the worst and with those changes, the economic benefit derived from the Mexican assets of the companies we own could be impacted. The fact that taxes and royalties could increase also represents a high risk. All of this affects the profitability of the companies we own and impacts their valuation.

 

Q: How are the major silver and gold trends shaping the investment sphere in 2021?

A: In 2020, Gold climbed to an all-time high after the impact of the pandemic and the ensuing global economic crisis. Investors considered gold a safe haven to hide from all the uncertainty.  In late 2020 and early 2021, news of a vaccine, the world reopening and economies starting to return to normal, affected gold and silver’s appeal. However, after all the liquidity that has been and continues to be injected into the global economy, markets are now starting to worry about inflation.  That is when assets like gold and silver shine, no pun intended. Exposure to these assets has historically been used as protection against inflation.  

 

Q: How is the mining sector affected by these trends and what is your outlook for the rest of the year?

A: In the last bull cycle for gold, as the price of gold increased so did the cost of mining and producing gold. This meant that profit margins did not expand as much as expected.  What we are seeing during this cycle is that the gold price has been rising while mining costs have been stable. Companies are focused on maintaining their production costs at a contained level. Margins have expanded significantly, and the gold mining sector is generating a lot of cash.  A cost measure that we refer to as All-in Sustaining Costs (AISC) in the gold mining industry is at present around US$1,000 per ounce, on average. With gold at around US$1,900 per ounce today, this translates into US$900 per ounce of profit and significant free cash flows for these companies. A lot of this free cash is being given back to shareholders in the form of dividends and share buybacks. As shareholders, we are happy to see that free cash is also being invested using very disciplined capital allocation strategies across the sector. Companies are not building massive projects just for the sake of growing production, but rather, they are making sure that the capital is going to projects with high rates of return. With these types of companies and strategies, we believe that the future of the gold mining sector is bright, with the potential for even greater profit as the gold price increases.

 

Q: Between silver and gold, which do you see as the winning metal in 2021?

A: The silver price is up around 5 percent year to date, while gold is flat, so, thus far, silver is winning in 2021.  From an investment perspective, we think silver will follow gold’s lead, as both metals are used by investors as a safe haven and hedge against inflation. In addition, silver has a strong industrial demand component, which should grow during periods of global economic growth.  So, I would not be surprised to see silver continuing to outperform gold. With that said, the gold to silver ratio is around 68 at present, compared to over 100 in 2020, and in line with historical levels, so the opportunity for outperformance is lower compared to last year.   

 

Q: What are the main difficulties faced by investors, especially miners, in 2021 and what new problems could arise?

A: When it comes to the gold mining industry, companies have moved away from simply increasing production and are now intensely focused on growing returns and margins.  Increasing production just for growth’s sake, even if this production comes at higher costs and reduces margins, does not make economic sense. The industry is in great shape and even with a flat production profile, in a rising gold price environment, these companies will realize free cash flow growth. One risk I see is cost inflation in the industry. We are seeing some signs of pressure in the mining industry already, where wage inflation and higher consumable and construction material costs could directly affect production costs and margins. We are keeping an eye on that, but we feel confident that companies will maintain their sharp focus on cost controls. The other risk I see is that as the gold price increases, there is a higher risk that more jurisdictions will start to look at the higher metal prices and determine that they need to increase taxes and royalties on the gold mining industry. 

 

Q: What advice would you give to those interested in starting to invest in mining?

A: The reality is that there are so many things that could affect the price of gold, and it can be very difficult to understand. However, I recommend investigating the historic performance of gold, especially during crises and inflationary periods. Compare that data to other asset classes and it should give you a very good idea of the role gold plays as a portfolio diversifier. I recommend having gold as insurance. Just as with life and medical insurance, you hope you will never need to use it but having it is a no brainer.

 

VanEck is an ETF and mutual fund manager, offering active and passive strategies supported by well-designed investment processes. Its strategies are fueled by in-depth, bottom-up research and security selection from portfolio managers with direct experience in the sectors and regions in which they invest.

Paloma Duran Paloma Duran Junior Journalist and Industry Analyst