Gold and Precious Metals Mining Equities—Regaining Their Luster in 2019

The changing dynamics in the market and economy have fared well for gold and precious metals

Gold and precious metals mining equities—as represented by the Philadelphia Gold and Silver Index (XAU)—are performing solidly in 2019, having climbed 36.5% year-to-date through August 9.  Changes in the macroeconomic environment and overall market volatility have made both bullion and precious metals mining securities more attractive to investors.  Those investors seeking a non-correlated asset class that may provide differentiated return characteristics in today’s volatile markets might want to consider the gold and precious metals mining equities as a part of their portfolios.  

A more challenged macroeconomic environment creates a tailwind for gold 

A convergence of factors is pushing physical gold and precious metals mining stocks higher this year. Gold is a hard asset that has performed well in a slower growth environment when equity markets are facing higher volatility, geopolitical turmoil is brewing, real interest rates are stable or falling, and/or investors fear weakening currencies. Many of these factors have been manifesting themselves concurrently in 2019. Several other factors that tend to benefit gold remain intact, including easing monetary policies, fiscal stimulus, low to negative interest rates, and lackluster economic growth. This combination of factors explains why physical gold is up 16.5% year-to-date through 8/9/19.1  

With respect to gold and precious metals equities, the primary driver of their strong performance this year has been the rising price of gold and other precious metals. Because the mining equities have both earnings and operating leverage to metals pricing, gold and precious metals equities have historically outperformed the price of gold by twofold to threefold when both bullion and precious metals mining stocks have risen. That has certainly been the case since gold hit a multi-year bottom at $1,051 per ounce in December 2015. It has also been true so far this year with the XAU Index having outperformed gold by more than double.2 (See Figure 1).  But there are other reasons for the strong performance as well. The health of the precious metals sector is significantly better than it was during the last cycle. Balance sheets are stronger, mining companies are generating cash, and management teams are staying more disciplined.

To be clear—we do not know whether the next $100 move in gold will be up or down. Short-term moves in precious metals are notoriously difficult to predict on a consistent basis. In addition, leverage can work both ways. When precious metal prices fall, the mining equities may decline to an even greater degree. What we do know is that multiple factors have come together this year to push both gold and precious metals mining equities higher. We also know these factors are complex, varied, and geographically dispersed. 

Figure 1: Performance of Gold Mining Equities vs Gold
December 18, 2015 to August 9, 2019

Source: Bloomberg, 8/12/2019.

Why gold and precious metals mining equities

In our view, there are several reasons why investors might prefer gold and precious metals mining equities over physical gold. For investors with a constructive view on precious metals prices, gold and precious metals equities have typically outpaced the upside performance of bullion because of corporate operating leverage and amplified earnings. In addition, both gold and the precious metals mining equites have low correlations to traditional stocks and bonds, and mining equities have even lower correlations to bonds than gold bullion itself, a circumstance that can make them attractive to investors seeking overall portfolio diversification.3 While bond pricing may be strongly influenced by interest rates and credit spreads, the financial performance of precious metals miners is more a function of the operating performance of their underlying assets. Furthermore, precious metals equities offer investors access to dividends, mineral diversification and the opportunity to benefit from corporate actions (including mergers and acquisitions), none of which are available by investing in physical gold. 

Why active management for precious metals stocks

We believe active management can produce solid results, relative to a passive approach, for several key reasons. First, the sector is highly dynamic at the operating level. Second, the gold and precious metals equities are volatile. Bottom-up research and careful security selection matter in this space. 

A talented portfolio management team running an active strategy can:

  1.  anticipate and adjust to changing conditions in the sector
  2.  modify exposures to both favorable and unfavorable operating conditions and geographic regions
  3.  sidestep problems as local operating conditions or regulations change
  4.  adjust position sizes in response to changes in company and sector fundamentals, valuations, M&A, and other factors.

In our view, active management can help deliver upside participation combined with downside mitigation. A static ETF can be challenged in doing so because it is more exposed to sector-level volatility and does not have the flexibility to reduce its regional or company-specific risks. 

Making room in a portfolio

Gold and precious metals equities can be effective portfolio diversifiers and have the potential to deliver attractive total returns, but they are volatile and sector timing is difficult to do consistently. Consequently, we favor a longer-term strategic allocation over a shorter-term tactical one. Investors need patience to capture the total return potential of this asset class, and they need appropriately sized positions so that they can look beyond the day-to-day volatility of commodity prices and the price movement of precious metals mining stocks  For investors who allocate 10% to 20% of their portfolio to alternatives as they pursue diversification and non-correlated return streams, we believe a position in gold and precious metals equities can be an effective component of that allocation. 

A long-tenured manager

Shanquan Li has managed Invesco Oppenheimer Gold & Special Minerals Fund (OPGSX) since 1997, a tenure that makes him one of the most experienced portfolio managers in this category.

Learn more about the strategy’s historical performance and ratings here.

Footnotes

1. Source: Bloomberg, 8/12/19.

2. Source: Bloomberg, 8/12/19.

3. The XAU Index has a correlation of 0.16 to the S&P 500 and 0.25 to the Bloomberg Barclays U.S. Aggregate Bond Index for the 10-year period ending 8/9/19.  The S&P GSCI Gold spot price has a correlation of 0.07 to the S&P 500 and 0.41 to the Bloomberg Barclays U.S. Aggregate Bond Index over the same period.  Source: Morningstar, 8/12/19.

Important Information

Blog header image: Steve Halama / Unsplash.com

Correlation expresses the strength of relationship between distribution of returns between two data series. Correlation is always between +1 and –1, with a correlation of +1 expressing a perfect correlation, meaning that the two series being compared behave exactly the same, a correlation of –1 meaning the two series behave exactly opposite and a correlation of zero meaning movements between the two series are random.

There are no guarantees that the historical performance of an investment, portfolio, or asset class will have a direct correlation with its future performance.

The risks of investing in gold and precious metals include fluctuations in price that may affect the profitability of companies in the gold and precious metals sector. Changes in the political or economic conditions of countries where companies in the gold and precious metals sector are located may have a direct effect on the price of gold and precious metals.

Leverage created from borrowing or certain types of transactions or instruments may impair liquidity, cause positions to be liquidated at an unfavorable time, lose more than the amount invested, or increase volatility.

Diversification does not guarantee profit or protect against loss.  

The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds, and is an indirect, wholly owned subsidiary of Invesco Ltd.

John Corcoran is a Senior Client Portfolio Manager for the Real Estate and Real Assets team.

Mr. Corcoran joined Invesco when the firm combined with OppenheimerFunds in 2019. Before joining OppenheimerFunds in 2011, Mr. Corcoran was a portfolio manager and senior equity analyst with Noble Partners, a hedge fund where he focused on commodities, energy, precious metals, and other sectors. Prior to joining Noble Partners, Mr. Corcoran was a portfolio manager for Brevan Howard Asset Management, a multi-strategy hedge fund. He has also held senior investment management positions at Fortis Investments, Harbor Capital Management, CIBC World Markets, and Stephens Inc. Mr. Corcoran has been in the asset management industry since 1997, focusing on portfolio management, fundamental research, business development, and product management. Before transitioning to investment management, Mr. Corcoran practiced law at Gibson, Dunn & Crutcher, where he specialized in complex business litigation for Fortune 500 clients.

Mr. Corcoran earned an MBA from Wharton Business School at the University of Pennsylvania, a JD from Boston University, and an AB degree from Harvard College.

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