MASTERCLASS: Fixed Income - February 2021
February 10, 2021
Jenna Dagenhart: Hello, and welcome to Asset TV's gold masterclass. With extremely low interest rates, the coronavirus pandemic and several risks on the horizon, people seem to be pouring into gold. Today we'll look at what's driving this safe havens outperformance and where the asset could be headed from here. Joining us now to share their outlooks and more, are two expert panelists Ed Coyne, Senior Managing Director at Sprott Asset Management and Ima Casanova, Deputy Portfolio Manager, Gold Strategy at VanEck.
Jenna Dagenhart: Everyone, thank you for joining us, and to set the scene here, gold keeps hitting new all-time highs and recently rose above the $2,000 an ounce mark for the first time ever, Ed, starting with you, what's been driving this record performance?
Ed Coyne: Sure. Well, obviously the last six months or so the market has been driven by the pandemic, but you really have to go back to the fourth quarter of 2015 to understand what's really been driving the gold market, and ever since the Fed attempted to tighten back in the fourth quarter of '15, gold has continued to match forward since then. In fact, prior to the pandemic, gold was averaging over 10% a year and performing quite nicely. This was really a phase two of what we think is a more prolonged bull market that really started in the early 2000s, when you looked at what happened with the tech bubble and then the global financial crisis. Gold is continuing to get a bid as we move forward, because it's become more of a modern metal.
Ed Coyne: What I mean by that is, more and more asset managers and more and more investors are looking at gold, not as the commodity, but really more as an alternative asset from a performance pattern standpoint. So, it's really been about four and a half, five years that gold's really been performing quite nicely relative to the broader markets, but really in the last six or seven months, you've seen accelerated move in the market largely because of the pandemic. It's really not just the pandemic, it's the Fed fund policy statements, which are actually necessary and needed right now. But they're getting a little ahead of themselves from a debt standpoint and from a money printing standpoint. So, a lot of those things are really driving the gold price today.
Jenna Dagenhart: Yeah. Ima, I see you nodding your head over there. Anything that you would add that you think has been driving this price?
Ima Casanova: Yeah, I agree with what Ed has pointed out, like he said that this gold bull market started in 2016, end of 2015, beginning of 2016. Obviously, the pandemic really took gold through higher levels, but I think at different points, different factors drive gold. What we see driving gold today is negative real rates, low rates and negative real rates are very positive for gold, and that's the main driver today. There's a lot of systemic risks in the financial system that also is driving gold, the fact that we have debt at record levels, and that brings a lot of instability into the financial system, which is what gold responds to, all the liquidity being pumped into the system, all of this monetary policy, the potential unintended consequences of this, and ultimately if it could lead to inflation, all of that is what we see today driving gold.
Jenna Dagenhart: Yeah. Ima, do you mind elaborating a little bit more on some of those systemic risks that you mentioned?
Ima Casanova: Well, like I said, different factors drive gold, on the negative real rates, we don't see any potential for that to change in the near future, rates are very likely to remain low or probably get even more negative. The Fed, it's not going to increase rates anytime soon or ever in the foreseeable future, so that will continue. The other factor obviously is U.S. dollar, gold is negatively correlated to the U.S. dollar, and the past bear market for gold that was really the largest hit win for gold with the U.S. dollar strength. This year, the dollar has weakened a bit. It hasn't weakened too much, but if that were to happen and there seems to be now look for a weaker dollar, then that will also help gold's performance.
Jenna Dagenhart: We'll dig deeper into the dollar and the Fed later on in this panel event. But before we get there, sticking with some of the record rallies that we've seen, it's not just gold, we've also seen at record rallies in equity markets. Ed, what does this say about people's confidence in the economy and why is gold important there?
Ed Coyne: Sure. I think what we're seeing today is what we've seen the last couple of years where you've seen the equity markets do quite well and gold do well along with it. So, people say, "Well, is gold now becoming correlated to the equity markets?" The reality is, as more and more investors realize that, "Yes, they have to participate in the equity market. Yes, they need to own dividend paying stocks, and over multiple market cycles, you have to stay invested in the market." But what they also understand is that the market is becoming more and more volatile, and volatility can be a good thing or a bad thing, right? Volatility is also ... price is going up as well as price is going down.
Ed Coyne: So, what we're starting to see is more and more investors, not just looking at gold, but looking at alternative strategies in general, that perform differently at different times, and that allows them to stay invested in the market. I think all too often investors think about gold as gold verse stocks, gold verse the S&P. The reality is, it should be gold and the S&P. What gold does is, gold allows you to stay invested in the market over full market cycles, knowing you have a portion of your assets allocated something that performs differently for different reasons. So that's what I think we're seeing right now.
Ed Coyne: Yes, the market has rebounded back quite nicely because so much liquidity is being pumped into the market, and there's really no other alternative to put that capital, but you're also seeing gold continue to climb as well because people are going for the ride, but they're putting on the safety belt, and gold's really that safety belt, and that's what we're seeing right now in the broader markets.
Jenna Dagenhart: And they wonder, where could we go from here? Ima, I know VanEck's come out with a very bullish price target on gold. You rarely set price targets, but you have recently at $3,400 an ounce, what's behind this?
Ima Casanova: Yeah, no, you're right. We typically don't come out with a target, but we have this year, we have published our official VanEck outlook of $3,400 per ounce, which is quite a bit of appreciation from here, and it can feel like a big move. We're not suggesting that we're going to reach that target in the next few months, but I think we do see that as a longer term target, whether that's two or three years from now, it will depend on where those catalysts come in and it really could be next month, but I think more likely in the next six months or so, gold will remain range bound in that 1900, $2,000 level that we've seen it trading recently.
Ima Casanova: But we certainly see all the factors that we outlined earlier supporting gold, its role as a safe haven, its role as insurance policy when global financial risk is tightened, we'll continue to support it in the longer term. So, we see that $3,400 target maybe even a little bit conservative.
Jenna Dagenhart: Some people might say, "Oh my goodness, look how high gold has already climbed." That being said, Ed, do you think it's too late to join the gold movement or is there still more room to run?
Ed Coyne: At the risk of selling and pumping up the tires of our asset, not at all. In fact, what we're seeing is we're seeing the circle expand right now as far as the investors that are expressing interest in the space. We're getting more and more unsolicited calls from larger institutions who haven't really thought about allocating gold since the market peak back in 2011. So, it has been grossly under allocated to for the last almost decade now. What we're seeing is people say, "Okay, maybe there is something to the gold tray. Maybe there is something to gold relative to the U.S. dollar, gold relative to the S&P, maybe there is something to that factor."
Ed Coyne: So more and more investors are now taking notice of the allocation and looking at it, again, like I said earlier, not just as a commodity but really as an alternative asset and putting in that alternative asset sleeve within the diversified portfolio. You have to remember, 20 years ago, it was very difficult to allocate the physical gold, right? You didn't have the ETFs and the close end funds and the mutual funds in these liquid vehicles in ways to allocate the physical metal. Today, there is many options for an investor to allocate to the space. So, it's now just entered into the modern world of diversification, the modern world of an alternative strategy.
Ed Coyne: So, this new move in the market, this recent move in the market really has brought the circle of investors in, that maybe were on the sidelines and not really paying attention. So, we think we're actually in the beginning stages of a prolonged bull market for gold, particularly because we think you're going to see rates lower for longer, you're going to see the debt probably continue to climb, you're going to see GDP continue to struggle. A lot of these things out there aren't going away anytime soon. So yes, we think that sure gold has moved nicely, but by no means is this the back end of the trade, this is actually an RV at the beginning of it.
Jenna Dagenhart: To your point, Ed, about all these different investment vehicles, it's not like you have to own bullion in your basement to have a stake in gold.
Ed Coyne: That's right. You don't have to do that, although some of our investors do have some in their basement. We have some investors that have it in the foundation of their house, but no, you're right. There's no one way you have to own it today, there's multiple options. What we're finding is the larger investors, the big institutions, the private families, they do want to have direct ownership of the metal, paper contracts really isn't something that they're comfortable with or interested in. There's a place for both, though. So, depending on the client and what they're trying to do and accomplish with the allocation, some want to have the physical ownership.
Ed Coyne: We offer trust that allows that, other asset managers offer opportunities to do that as well. Some are just fine getting exposure to spot price and simply just trading the spot price action. So, there's a lot of different ways to do it today, but I would say the serious money, the big institutions, the large private families, they do want to have some physical ownership because they want to have portion of their capital allocated away from the traditional stock market.
Jenna Dagenhart: So more and more people are taking notice of gold, as you say, but do you think it's still underutilized? It sounds like, yes.
Ed Coyne: Oh, it's incredibly underutilized, is less than 1% at least in the U.S. and I can't speak to the global allocation, but in the U.S. is well under 1%. At the market peak, it represented about 7%. So, we have really no one paying attention. In fact, people are paying attention to the physical side, but no one's really paying attention yet to the equity side of the gold trade, which is something we're enthusiastic about and very excited about for the next three to five years because of the margin expansion, which I suspect we'll talk about later today as well.
Jenna Dagenhart: Yeah. Ima, I see you nodding your head again, anything that you would throw in there?
Ima Casanova: No, I mean, when Ed mentioned margin expansion and the equities, that's our sweet spot, we as well provide the whole suite of investment opportunities from physical gold, which can be delivered, which investors really like with our OUNZ product, but also with our ETFs, then our active products for gold equities. So, I agree the opportunities there are really exciting because margins are indeed expanding as the gold price rises.
Jenna Dagenhart: And Warren Buffet would say, "Hey, but it doesn't yield income." Ed, what would you say to people, what's the case for owning gold? Why own gold?
Ed Coyne: Sure, sure. Well, first, Warren Buffet as most people know, they recently took a meaningful position, maybe not relative to Berkshire size, but relative to the company size in a large cap mining stock. So, for the first time and I think everyone in a very long time, they've actually started to allocate to gold. Some of the larger cap companies on the equity side do pay dividends, on the physical side though, Buffet does like to knock on gold and say, "It's yellow rock that you should dig out of the ground and then you dig another hole in the ground and put it back in and you just spend money." But the reality is, as smart as Buffett is, he doesn't really understand the purpose of gold.
Ed Coyne: Stocks are designed to make you money, stocks are designed to have dividends and have earnings. Gold is designed to protect those dividends, protect those earnings, to diversify the portfolio. That's really the benefit of gold. It's an asset that performs differently at different times for different reasons, period. I think the investor that tries to compare gold to a stock misses the whole purpose behind the allocation. I think that's why so many people haven't allocated to it because they don't know how to value it.
Ed Coyne: In the simplest form, gold is an alternative currency. When you think about what gold does and how it performs, it's an alternative currency, and that's how people should think about it. It's just another currency out there, it's a true store of value. The dollar is not really a store of value, A, the purchasing power has been completely diluted, and B, over the last five years, the U.S. dollar is actually down a little bit. So, when you think about gold, think about it as an alternative currency, think about it as a true store of value. Think about it as a true alternative asset in a way not to replace your stocks, but to really compliment them.
Jenna Dagenhart: Yeah, those are great points. Last time I checked, no one has ever called stocks a safe haven or a store of value or any of those things.
Ed Coyne: That's right.
Jenna Dagenhart: Ima, how would you say that the high price of gold has changed your company research? Is it easier or more difficult to analyze individual companies or projects?
Ima Casanova: It doesn't really change much the work we do from a research perspective, we maintain and generate our own internal models at VanEck, and so everything is linked real time, so the gold price. So, at any day we wake up and we can run our models at the higher prices at the whatever the currency prices are and get new valuations to assess the relative value of all the stocks. So, it doesn't really change that much from that perspective. I think what it does, and it probably will do, is that it will increase our research universe a little bit in that there'll be more projects that now will be looked at, companies will start to review projects that didn't work at 1200, $1,400 in gold, but that start to become economic at $1,500 in gold and so forth.
Ima Casanova: So, from that point of view, I think we'll be looking at more companies, more projects and more companies as a result, which is great. This is a relatively small space, so the opportunity to look at more ideas from a research perspective is obviously beneficial.
Jenna Dagenhart: I want to take a step back and look at how gold has performed over longer periods of time, say 5, 10, 15, or even 20 years. Ed, what can we learn from these other periods?
Ed Coyne: Sure, what's interesting is, there's a particular chart that we like to show that starts in 2000 and virtually every investor that I show it to, they don't believe me, that gold has actually outperformed the S&P for the last two plus decades. In fact, the only time it really has is from 2011 to 2015. Since that [inaudible 00:16:32] actually ... Believe it or not, since 2016, gold and the S&P are up virtually identical. So, it's been really interesting to think about gold over multiple market cycles. You just don't need a pandemic for gold to outperform, and really, it's the old kind of win by not losing, talking about gold being a store of value, it continues to rise with the rate of inflation.
Ed Coyne: So I'd say if you get a doubling effect on the inflation rate, so let's say inflation is running at 2% and gold's averaging 4%, then it's doing its job, frankly, it's been doing much more than that because there's been so much volatility in the market between the tech bubble, the global financial crisis, the trade war, the Fed attempting to tighten in 2015, and now the pandemic, we're getting a compressed market cycle that has more and more volatility in it, and so in that environment gold is doing even better. But if you think about gold just from a performance pattern standpoint relative to inflation, for the last two decades, it's done very well. I use the last two decades really because of what I said earlier about gold being a modern metal or modern allocation today.
Ed Coyne: In the 70s and the 80s, there was time periods where gold did very well and there's time periods that it didn't do well, but it wasn't as accessible as it is today. So, that accessibility has really brought gold into the forefront as a legitimate allocation, as a way to hold it on a balance sheet and show it to your client and how it performs, and it's accessible in a way that it hadn't been. So, the last 20 years is a really good timeframe to look at what gold has done over multiple market cycles in both bull markets and bear markets. But the thing that always surprises people over the last 20 years is, gold's been one of the best performing assets out there, period.
Jenna Dagenhart: And pardon the pun, but there's no denying that gold has been shining quite a bit lately.
Ed Coyne: Yes.
Jenna Dagenhart: Ima, when was the last time gold performed this well, and do you see any similarities between then and now, what's different?
Ima Casanova: Yeah. I think we like to look at the previous secular and cyclical gold bull markets, and what we find is that this bull market that we're saying began in end of 2015, early 2016, it's tracking more closely the gold bull market of 2001 through 2008. In that cycle, gold was up almost 300%. That's part of what makes us also very bullish about the trajectory of this gold bull market and why we also think we're in the early stages. So, that looks very similar to that period, there are obviously differences that are I think make this cycle even more positive for gold in that, in those periods real rates were in negative, in those periods, central bank's balance sheets didn't look the way they look today with trillions and trillions of dollars.
Ima Casanova: The monetary policies being implemented warrant the tools that are being implemented today, and so there were differences, back in the 1000s, there were a lot of gold discoveries still. We have a chart where we show gold discoveries throughout the years, and there is really not been any major gold discovery in recent years, while in the 2000, these companies were spending on finding gold. So, from a supply perspective, it still looks a lot more positive today. Central banks were net buyers of gold back in that and during that gold bull market, they have been gold buyers for 10 years in a row now. So, there are obviously similarities, and I think there are other aspects that make this gold bull market even have more fuel.
Jenna Dagenhart: We've talked a lot about gold here, what about silver, Ed?
Ed Coyne: Sure. Silver has gotten a lot of attention as we've all seen in the last quarter or so, it's done very well here more recently. Silver is a true hybrid metal. What's unique about silver is that there's a lot of industrial applications to it. From a monetary standpoint, central banks aren't typically buying silver, they really don't do that. A lot of institutions don't really allocate to silver, but a lot of retail investors do. So, there are times when gold starts to move, silver starts to play a bit of catch up and can have very violent swings up, but also have violence swings down. So, some people like to talk about the gold to silver ratio, which is sitting around 72 or 73 right now.
Ed CoyneIf you look at the earlier part of the year, the gold, the silver ratio was over a 100. So, a lot of the "silver bugs" were really enthusiastic about the future of silver, and it proved to play out. Silver has done extremely well year to date. So, think about silver more as a retail allocation, think about silver as more of a hybrid application and use more in the industrial markets, whether it's for medical devices, solar panels, flat panel TVs. There's a lot of things that silver can be used for that typically gold is not, even if you're talking about battery technology and reflective technology for self-driving cars and so forth, there's a whole other market in silver, whether it's the recycling side of silver, the industrial side of silver, but from an investment standpoint, I think it's more retail, and not so much institutional. So, they're going to perform a little differently.
Ed Coyne: If you're truly looking to have a hedge to the broader markets, I would say, stick with gold. If you're looking to opportunistically trade the metal prices, then silver could become quite interesting.
Jenna Dagenhart: And Ima, what factors outside of systemic risks have been impacting the price of gold, i.e. supply and demand, and have there been any notable changes or trends in these factors, which might also be impacting gold prices currently?
Ima Casanova: I think it's important to point out what I believe it's an important change, an important shift in investment demand, which ultimately is the driver of the gold price. What I mean is I see institutions, I see endowments, pension funds, investors and the markets in general is starting to shift from viewing gold as a quick trade, a tactical allocation, a way to play the market, a more speculative if you might, investment and play into shifting from that to viewing gold as a long term portfolio allocation, where gold just plays a role, not just for a few years, but permanently gold as a role, as a portfolio diversify or as a portfolio insurance, as a safe haven.
Ima Casanova: I think that shift can be very material. Globally, assets under management held in gold, it's less than 1% I think is something around 0.7%. So, you can see how just even a small tweak to that, just growing that to one and a half to 2% can have a material impact in the gold price. So, I think it is an important trend.
Jenna Dagenhart: Ima, given the record level of gold and the expectation that this may last, do you see companies changing their spending? Are there other initiatives that these firms are engaging in now that they weren't able to do previously, technology, R&D spending larger exploration budget?
Ima Casanova: Yes, I think that is a great question, these companies are generating a lot of free cash, at $2,000 gold, at $1,800 gold, these companies are producing a lot of cash and we were very cautious to see where they're going to deploy that cash. What we're seeing in this cycle and with the companies, the way the sector looks today is that the companies are very disciplined. They are very careful in what they're doing with that cash. So yes, obviously exploration spending will increase and companies have more money, they'll be able to invest more in exploration, and certainly in some of those other areas that you mentioned, R&D and technology will be focused, but I think companies will continue to use free cash flow to repay debt, to make their balance sheets even healthier. They will use it to increase dividends.
Ima Casanova: This is a pretty low dividend yield sector, historically has been, and so we see a new trend where companies are increasing the dense. So, they're using the cash flow to return it to shareholders. They're buying back shares when they can, taking advantage of historically low valuations. They're being careful to not go and buy things for the sake of buying things. That's old news, they are using their cash more conservatively to grow their organic pipeline. We see more preference for expansions, for lower CapEx projects, which obviously decreases their risk in these projects, so we like it. A preference for that instead of going to buy new project or new companies at high prices, which proved to be very ... But value-destructive in the past. I think the companies have shown to be disciplined in their capital allocation, and it is early in this cycle, but everything points to them remain in discipline in that front.
Jenna Dagenhart:Turning now to the Fed, which I know you brought up earlier Ed, the Fed recently came out saying that it would be willing to tolerate a higher inflation. Tell us about the reaction in gold market Ed, and how this could impact the rally long-term.
Ed Coyne: Sure. I mean, we've both talked about this quite a bit, the whole concept of a store of value and that's really ... at the end of the day when you strip everything else out, that inflation plus two concepts, if inflation is five, I would expect gold to be at seven on the conservative side. That's really what you want to see happen in the gold trade, that's really what people talk about when they talk about gold as a store of value, is that it maintains its purchasing power for decades, for centuries frankly. When you look at what gold's done from an appreciation standpoint, over multiple, multiple, multiple market cycles.
Ed Coyne: 27:29 So, the inflation story with the Fed allowing inflation to potentially run, frankly, it already is here in asset prices, right? You've got cost of capital so cheap that most CEOs are borrowing capital and buying back stock and driving their stock prices higher, that has continued to happen. So, you've seen asset prices inflated, and now you're seeing day to day items start to inflate slowly, some people talk about it from a deflationary standpoint, and gold can do well in that environment as well.
Ed Coyne: Basically, anytime there's uncertainty or lack of certainty in the directional price of the markets of inflation, deflation of the value of the U.S. dollar, gold serves a role there. So. with the Fed being in support of some more inflation, because frankly, let's be honest, that inflation will help the debt burden, right? So, we've got over seven trillion in debt today. We got to deal with that in some way, shape or form, and inflation is one way to do that. So, of course they're going to allow inflation to run a bit. In that environment, gold becomes a mandatory asset. You really do need to think about having an allocation into that space because of its historical performance patterns in inflationary times.
Jenna Dagenhart: And I know the Fed has said that it's not even thinking about raising interest rates-
Ed Coyne: No.
Jenna Dagenhart: But if the Fed does raise rates, eventually they start going up. What will that mean for gold, Ed?
Ed Coyne: Sure. Well, interest rates rising isn't necessarily a bad thing. The last time we had rates rising, gold did quite well. So, the directional move in interest rates really isn't what you should be focusing on. What you should be focusing on is the why behind interest rates. So, let's just take 2016 for example, the Fed started raising rates in the fourth quarter of '15, and gold started rallying on that. The reason why it rallied on that is because the market understood that rates had to go up in the event the market sold off, they needed some ammunition, some dry ammunition to lower rates again, and thankfully we were able to raise rates to a point to where we could start lowering them again when the pandemic hit.
Ed Coyne: So, it's really the why behind the directional move of interest rates, not the actual directional move or how much rates have moved. So, you have to really peel it back and try to understand why rates are going up or going down in the broader market, and in many cases, that's going to be supportive of golds. So, we wouldn't say rising interest rates would automatically be bad for gold. Now, real rates may be bad for gold, but Fed fund rates not so much.
Jenna Dagenhart: I'm glad that you bring up real interest rates, Ima, can you talk to us in a little bit more detail now about negative real interest rates and dollar weakness and why they matter so much to the price of gold? Are we likely to see one or both of these in the next several years?
Ima Casanova: Yeah, so I think the big knock on gold is always, "It doesn't generate any income." That's what Warren Buffet was saying. That's what a lot of market participants say, "Why would I hold gold? It doesn't give me an income." But when you're competing assets are not just generating income, but yielding negative rate, which we have trillions and trillions of negative yielding debt right now globally, then it becomes a lot more attractive to own gold. So that makes it very clear to understand why negative real rates are positive for gold. Then like Ed mentioned, it's not just interest rates, interest rates can increase, it's really how that compares with what's happening in inflation and deflation as long as inflation is increasing, and that's why, say, the Fed now that they have a higher inflation target this size to hike rates, which obviously we don't see, but if that were to happen real rates are likely to still be negative which again is supportive of gold.
Ima Casanova: Our outlook for the U.S. dollar, I think it depends very much on how we [rise 00:31:34] through this pandemic, not just how we do it here in the U.S. but how the rest of the world does it, who comes out of this sooner? Who can open up their economies faster? And if that needs appreciation or depreciation of different currencies that will affect the outlook of the U.S. dollar, but certainly we don't see U.S. dollar strength as a headwind for gold, which had been in the past. So, when you ask, "Can we have one or both of this?" I think a more likely scenario is that we will for the foreseeable future have both negative real rates, and either a stable or a weakening U.S. dollar, which will be supportive for gold.
Jenna Dagenhart: Ed, do you agree?
Ed Coyne: Absolutely. I mean, the dollar is interesting. Everyone says, "Well, gee the dollar, it's such a safe haven." If you look at the actual return patterns of the dollar, it's basically been flat to slightly negative over the last five years. So, the dollar's purchasing power continues to erode over time, even in the most modest inflationary times. So, those dollars need to be invested into the market to actually earn any kind of interest. When interest rates are so low, the dollar is really not that great of an investment. So, dollars are great to go buy your coffee on the corner, but day in day out, it's not really a great investment. So, you need to think about every asset out there as an investment. How are you going to put that asset to work for you? What is it going to do for you? And frankly, what has it done for you over the last 3, 5, 10, 20 years?
Ed Coyne: So, yeah. We think the dollar is going to continue to be under pressure. Look, you can't keep printing something and putting one, fives, tens and fifties on it and expect it to hold its value as you print more and more of it. So, there is definitely a dilution effect that's happening in the U.S. dollar today. Frankly, we don't want it, there's a lot of Fed policies that don't want to see a strong dollar also because we still need to be a global leader from a commerce standpoint. So, a strong dollar would hurt us in that regard as well. So, there's a lot of reasons why the dollar ... we don't think it's going to get strong anytime soon.
Jenna Dagenhart: Ima, you've said that this is a deflationary driven gold market, but can you address this scenario where stimulus leads to inflationary pressures and how would gold likely respond?
Ima Casanova: Yes, gold response to both scenarios, it responds to risk [inaudible 00:33:55] financial system. So, both deflation and inflation are good drivers for gold. What we have seen is that in periods of elevated inflation, of higher inflation, gold does respond better. So should these policies and all the money being injected into the system lead to higher inflation which I think most of us expect at some point, then we would expect an even stronger response from gold in those cyclical and secular markets, where we saw periods of high inflation, gold that time throws as much as 500%. So, inflation is certainly a stronger driver of gold.
Jenna Dagenhart: And I know, Ima said end of 2015, early 2016, Ed, in your opinion, when do you think the most recent bull run in gold truly began?
Ed Coyne: Well, we would be in the same camp with that. I'd say, you look at the bull run really in two phases, right? The super cycle as we like to call it, really started in 2000, but the most recent cycle was when the Fed attempted to tighten, when the Fed said, "We're going to start tightening." And the world looked around and said, "Well, I don't know if that's going to work because there's not enough supportive GDP out there to really justify a higher interest rate environment." So, when that happened, the first half of 2016, gold goes up very strongly. It was up over 20% and the gold equities up over a 100, albeit from a lower base, but the market reacted very strongly to the gold trade when the Fed attempted to push the pedal.
Ed Coyne: That's why I said earlier about, you have to understand the why behind the Fed's response to some of these things and understand that what gold can or can't do in that type of environment. So, we would agree, we would say that the fourth quarter of 2015 really was the start or the fuel for the most recent cycle that we're experiencing right now. Where gold's up 80, 90% from that moment in time. But the super cycle, as we like to call it, really has been going on for about two decades, and we think as you continue to see more volatility, as you continue to see more financial and geopolitical uncertainty in the market, gold's going to continue to serve as a role, and we're going to see more and more investors as I mentioned earlier [inaudible 00:36:21] investor circle continue to widen and see more people think about gold as legitimate asset and diversifying their portfolios.
Jenna Dagenhart: And obviously gold's been doing extremely well, but Ima, are there any market events or scenarios that might lead to a pullback in gold prices or a change in your bullish outlook significantly?
Ima Casanova: Yes, I think a vaccine is developed and widely implemented and it's successful that really changes the outlook of what this pandemic is causing, that would be negative for gold because that would mean people can get back to work and the economies can reopen. So, U.S. economy, global economy that recovers more quickly than what I think we're anticipating, would be negative for gold. If we didn't see any inflation starting to build up, that would probably lead to eventually some pullback in gold, because like I said, inflation expectations do drive gold. So, I think those morose scenarios, us getting out of this recession sooner would eventually lead to a pullback in gold prices.
Jenna Dagenhart: And Ed, I know it's not something that you necessarily want to think about, but what would it take to make gold change course?
Ed Coyne: Well, I think you're exactly right. Talking about a vaccine, which at some point we will have one, that's going to have a level of jubilation in the economy and in the market in the world. You'll see those types of emotional pullbacks in gold. Then we'd like to always segregate an emotional pullback, or an emotional rally verse a financial one, right? So, the financial issues are still all there, there's debts, not going to go away magically, the amount of money we've dumped into the market is not going away magically. A lot of these jobs that have been lost, we're going to find out are permanent losses and GDP is going to slow through that even if the economy has a short live Springback or bounce back.
Ed Coyne: So, there's an emotional reason why gold does well or does poorly, and there's a financial one. Regardless of what happens from an emotional standpoint, I.e., having a vaccine, which we will have at some point, hopefully sooner than later, you still have the financial issues that we have to deal with. So, I see, and we see as a firm, any pauses or pullbacks in the market is opportunities frankly, to allocate additional capital to this space, because it have to look at the long-term reasons why gold has done as well as it has for the last two decades, and a lot of those things aren't going away anytime soon. So, the lower for longer interest rates, the constant threat of potential inflation or deflation for that matter is real and going to be around for years to come, regardless of what happens with the pandemic.
Jenna Dagenhart: Ima, walk us through the best case and worst-case scenarios for the economy and the subsequent response of gold.
Ima Casanova: Yeah, I think best case is what we've just talked about. We have a vaccine sooner rather than later; we start to be able to reopen our economy and get things back in track. It's hard to be very bullish on that outlook, but certainly, in the best case, that vaccine comes sooner rather than later, and also governments across the world are able to deal with this pandemic in the way that we hope they do to really allow the economies to reopen. But with that said, even that best case still has a lot of risks that won't go away, and I think even in that best case, gold will do well.
Ima Casanova: The worst case, we continue to being ... or this recession gets even deeper and things get even worse, and we go into a cycle of hyperinflation which obviously would be extremely, gold bullish, but also there's a lot of other issues that servicing the social unrest in the U.S. then, especially that all could really complicate things and make it even worse. I needless to say that would be very positive for the gold price, but I think the way things are today, the most positive scenario or the worst bode really well for gold in the longer term.
Jenna Dagenhart: Now let's spend a little bit more time on equities here. Ed, how should an investor think about physical gold versus gold equities?
Ed Coyne: Sure. We always like to start by saying physical first, and what we mean by that is, investor needs to ask themselves, why are they allocating to the gold trade to begin with, right? So, gold traditionally is viewed as that hedge. So, physical first is really the right way in our mind to think about the allocation. Then as an investor gets comfortable with that allocation and sees what their gold allocation can accomplish in an overall portfolio, if they believe as we do, that gold is going to stay stable and or go higher. Then the gold equities become more of a tactical opportunistic trade. There's times you want to own gold equities, there's times you do not, but you need to own gold over multiple market cycles for it to really be beneficial in your portfolio from a diversification standpoint.
Ed Coyne: So they are very different in that regard. But if you think gold is going to be flat to positive as we do over the next three to five years, then the gold equity story becomes more and more interesting, because of the creation of free cash flow, margin expansion, gold miners in general, depending on where they are in the world, and what type of mine it is, whether it's an open pit or closed pit and so forth. They're roughly running at about 1100 bucks an ounce and 18, 19, $2,000 an ounce, these companies are very profitable. So, from a tactical allocation right now, a portion of your gold allocation, we believe should be in the equities, from an opportunistic standpoint today, given the narrative for the gold price, the physical gold price over the next three to five years.
Ed Coyne: So, you do need to think about them differently, think about the physical allocation as a way to diversify and protect your overall portfolio, and think about the equity portion of your portfolio, the miners, whether it's senior, more liquid miners or more opportunistic junior, small cap type miners is a way to add additional torque to your portfolio and a greater leverage trade to the price of gold. So, they are very different, they perform a bit differently at different times, there's different volatility factors you have to consider in both, but in this environment right now, we think both really are warranted in a portfolio, both physical from a core allocation and equity as an opportunistic allocation.
Jenna Dagenhart: Ima, you run a gold equity strategy. What do you believe are the most compelling reasons to be invested in the miners versus, say, physical gold?
Ima Casanova: I agree that a mix of both bullion, physical gold and equities is probably the right approach. We're often asked how much we should own in our portfolios, and we often say probably a 5% at least, somewhere in that 3 to 7% range is what you really need to be allocating the portfolio to really feel the benefits of owning gold. I do believe that a mix is the right approach, what that mix looks like depends very much on risk tolerance of each investor, clearly gold equities are more volatile, but they also have higher returns. The key is, once you form an outlook of where the gold price is going, in this case we believe gold price can go much higher, then in that environment, gold equities should outperform the metal. That's because of leverage, because as the gold price increases, the margins of this company expands significantly.
Ima Casanova: So, our case for the gold equities goes beyond just a higher gold price, it is not just that gold is going higher, which obviously it's needed and positive for the gold equities, but it's also the shape that this companies are in. These are companies that have been transformed over the last years and are sound businesses. Yeah, break-even is somewhere around 1100 or so at that level. So, you can see what things look like at 2000. I think because of the transformation of this sector, I would like to think that equities might start to be less of a speculative tactical play and part eventually of the broader equity market.
Ima Casanova: If gold companies can't make money at $1,200, if they're actually preferable, $1,200, and they remained discipline where reserves don't get priced all of a sudden, they're not trying to bring in reserves and bringing analysis that at 2000 and $1,800 gold, but they've remained conservative and keeping the quality of their portfolios, I think these are ongoing sustainable profitable businesses that could become part of a longer term equity allocation. But yes, if you have the risk tolerance and you believe that gold is going higher, the gold equities are the way to go to really realize those higher returns.
Jenna Dagenhart: Going back to our conversation about Berkshire Hathaway recently buying a stake in Barrick Gold, which is quite a reversal for Warren Buffet, who, as we talked about, has been a little bit against buying the asset, but anyhow, Ima, do you think that Buffet buying Barrick is a sign of capitulation or do you think he's just interested in this mining company?
Ima Casanova: I think it goes actually precisely to my point of the equities, notice that they didn't buy bullion, they invested in equities, Barrick of the largest gold mining companies in the world, and I think that's a testament to precisely the argument I was making before that this businesses are good businesses, dividend yields are increasing, which is a trend that we see continuing. So, the broader market can begin to look at this companies as part of their investible universe, and I think Buffet or his disciples, whoever decided to pull the trigger on that trade, making that move it's a huge message to the broader sector that they should be looking at this equities as good potential investment.
Ima Casanova: So, I think it's very positive obviously because of the fact that everybody's listening, and obviously the Barrick stock price reacted to the announcement. But I think it goes back also to gold being seen as a longer-term allocation, I don't think that's just for bullion, I think eventually gold equities as well will be seen as providing the same benefits that gold bullion provides diversification and insurance for portfolio. So, I think it's, like I said, the beginning of a new era for the gold equity sector.
Jenna Dagenhart: Ed, anything that you would add about the miners.
Ed Coyne: Yeah. I'd say on the miner side, I would agree with Buffet coming in, it is becoming more institutionalized, more of the larger cap, liquid names are paying dividends. So again, look at the directional price of the physical to get a sense of what you can expect out of the miner. So, we would agree with that, that the miners are coming into their own right now, and we love to see them be a more permanent part of an overall portfolio as those look to benefit from the overall directional price of gold. So, I do think you have to think about them though, from a large cap, more established liquid version versus a small cap, more junior version of the space. So, it would be similar to the way you look at the S&P 500 and the Russell 2000, say 15 or 20 years ago.
Ed Coyne: You have to dig a little deeper, not just buy a bunch of miners, but really use a manager who's going to understand the way the market works and understand where there's value, whether it's a single mine and the more junior small cap space or a more diversified company that has multiple mines and multiple regions in the large cap space, they're both value added for different reasons and both had different liquidity issues to them. So, I think you need to look at that from an active standpoint frankly, and have a manager involved with the stock selection process, because you can make a lot of money in this space, you can also lose a lot of money in this space. So, it's a wonderful place to allocate capital to over full market cycles, particularly when the gold price is moving like we're seeing it today.
Jenna Dagenhart: Ima, talk to us a little bit more about the juniors.
Ima Casanova: Yeah. Like Ed mentioned, they are riskier, more speculative investments, but they provide an opportunity to realize much higher returns. I think active stock selection is key in this space, we pride ourselves with having a team that has the technical geological engineering expertise to be able to pick this stocks, these junior stocks at early stages. The earlier you can discover that you can find this companies and believe that their gold deposit will eventually become a mine, obviously the higher the returns that you will realize. So indeed, they're less liquid names, they are more volatile, they're riskier from a technical perspective because obviously they're in development, but they allow for a lot of alpha generation if you pick the right ones at the right time.
Jenna Dagenhart: Before we wrap up this panel, I wonder, Ed, are there any misperceptions surrounding gold, any myths that you would like to lead a rest?
Ed Coyne: Yeah. Well, I wouldn't say it's a misperception, but I think the knock-on gold that we've touched on a few times that doesn't pay dividend, right? It doesn't have earnings, and so how do you make an "unproductive asset" productive? What we always tell people is what a lot of our institutional clients tell us, when I asked them, "How do they use gold in their portfolio?" They say, "Well, gold's a great allocation from a diversification standpoint, but you have to manage that allocation." What they mean by that is, and what we support is, you have to dial up and dial down that allocation based off these performance patterns.
Ed Coyne: So, if the year ended today and the gold market's up over 25, almost 30% year to date, and the S&P is up like 10. So, if that were to happen right now, you would want to trim your gold position and get it back down to 5% of your overall portfolio, conversely year like last year where the S&P outperform, you would want to actually be adding to your gold position and managing that 5% core allocation. If you just set it and forget it, unlike a stock that does pay dividends, it does have earnings and appreciates because of the dividends in many cases, gold doesn't do that. So, you do have to manage that allocation and dial it up when it's underperforming and dial it back when it's outperforming.
Ed Coyne: If you do that over a full market cycle, gold will become one of your better diversifying assets out there. It will be a true beneficial tool in helping you balance your overall risk reward balance in that portfolio. That's what we always like to tell people, is that, first understand why you're allocating to this space, and then second, once you make that allocation, you can't just set it and forget it and think it's a magic elixir to your overall portfolio. You do have to manage that allocation, you do have to pay attention to that allocation in a periodic rebalance, whether it's quarterly or annually or semi-annually depending on the tax sensitivity of that account. That is really how you get the most out of the physical gold market.
Ed Coyne: Then of course the equity side, again, if you believe as we do the directional price of gold, the equity market could be very interesting. Again, with the larger caps paying dividends, they're going to have a similar profile to a traditional stock, but on the physical side, managing that allocation is key. That's how you really get the most out of that core allocation in a portfolio.
Jenna Dagenhart: Ima, any final thoughts on your end that you'd like to share?
Ima Casanova: Yeah, I think on myths on how gold is perceived, I think it isn't just for gold bugs, it isn't just for conspiracy theory people. I think there's this perception that only people with gold under their mattress or in their basement were all a little crazy, were investing in gold. I think these times like we're having today, going through this pandemic, it's shining a light on that, on what happens during times of crisis, and the answer is that, gold outperforms, and gold does exhibit properties as a safe haven and a portfolio insurance. So, I think, like I mentioned before, that shift and that psychological shift that eventually might translate into investment and demand shift, it's an important trend that can have a huge impact in the gold sector.
Jenna Dagenhart: Ed, anything that you would like to leave our viewers with today?
Ed Coyne: I think, just think about gold as your core allocation, think about gold equities as an opportunistic allocation in this current environment. I mean, I think both should be part of your portfolio.
Jenna Dagenhart: Well, Ima and Ed, it's been a pleasure. Thank you so much for joining us.
Ed Coyne: Thanks for having us.
Ima Casanova: Thank you.
Jenna Dagenhart: And thank you for watching this gold masterclass. I was joined by Ed Coyne, Senior Managing Director at Sprott Asset Management, and Ima Casanova, Deputy Portfolio Manager, Gold Strategy at VanEck, and I'm Jenna Dagenhart with Asset TV.