Rob Crayfourd, portfolio manager at New City Investment Managers, explains how precious metals can act as an ‘insurance policy’ despite being unloved in the current environment.
The recent weakness in precious metals and the respective miners appears overdone and we believe presents an investment opportunity. 
Gold has historically provided protection during times of uncertainty, by providing an insurance policy for risks. We now have a number of ‘known unknowns‘ in Donald Trump, Brexit, record high debt levels, global populism distorting the status quo in politics, emerging market currencies collapsing and a rate hiking environment.
In the US equity markets haven’t seen a material correction for 10 years, there could be one around the corner. This is even before considering the ‘unknown unknowns’. Yet precious metals remain side lined for many investors. We believe that will change and precious metals should again see a role in protecting against these risks. We discuss some of these drivers below.
Precious metal prices are heavily influenced by physical ETF’s flows, which have seen a material reduction of 4.6 million ounces of gold over five months. In part this has been driven by the strong US dollar which has weighed on. This selling pressure will subside and may reverse on any escalation of the pre-mentioned risks, whilst Trump continues to try to talk down US dollar strength and would clearly like it weaker.
Central bank buying of gold has remained strong, especially as Trump sanctions have pushed many of them to diversify away from US dollars. This has accelerated central bank demand as the Argentine peso and Turkish lira have declined. Gold should be viewed as a currency, so arguably a beneficiary of this weakness. This has a degree of knock-on to the affordability in these respective currencies, but low gold prices have done little to dampen demand historically.
Against this backdrop the producers have been battling lower prices, ultimately reducing their capital expenditure in to new projects, which has resulted in declining reserves and falling grades for existing mines. This has led to reduced output and higher costs which will tighten the precious metal markets going forward
Mining equities have fared even worse, seeing their valuations compress further than the fall in precious metals. In part this is due to increased competition from crypto currencies and cannabis stocks in Canada. In addition to this the major junior precious metal miner ETF rebalanced to only include stocks over $1bn, further weighing on the smaller producers and explorers. These trends look likely to reverse, whilst the smaller cap producers and explorers are possible targets of takeovers to offset declining reserves.
In many cases weaker emerging market currency declines have been a benefit to the producers, reducing their costs if they operate there and supporting margins.
So yes, precious metals have been weak, but we still believe they have an important role to play as an insurance policy within an investment portfolio. The fact they are unloved today provides an opportunity, with a large number of catalysts that could see buying return. Importantly, the respective equities are at historical discounts, providing what we believe to be an attractive entry point. Gold has been a store of value for millennia and we don’t believe anything has fundamentally changed to end that.
Rob Crayfourd is co-manager of the Golden Prospect Precious Metals fund. The views expressed above are his own and should not be taken as investment advice.
