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24/09/20184 mins

As good as gold…

Going for gold

For centuries past, humans have coveted and revered gold. From the Aztecs in the 1400s, to the discovery back in July of the UK’s largest ever gold nugget, the lustrous metal has long captured imaginations. But lately, gold has fallen out of favour – and attracted our attention, as contrarian investors. In the current market environment, we believe that gold merits its place within our portfolio.

Historically, gold’s enduring appeal has been its ability to retain its purchasing power. It has a tendency to keep pace when inflation rises and also to act as a store of value in deflationary times. As well as being a store of value, gold symbolises status and longevity – gold is still associated with success.

And of course, gold has offered investors a safe haven when markets are turbulent and politics fray investors’ nerves. That appeal still holds true today. In a late-July interview, President Trump criticised the US Federal Reserve, saying that he’s “not happy” about the trajectory of rising rates. While he’s no stranger to a contentious remark, it’s rare for a sitting President to rebuke the actions (and risk undermining the independence) of the Fed. While markets took some notice, they have largely ignored the issue. But perhaps President Trump is on an inevitable collision course with the Fed.

For you see, President Trump’s pledge to “Make America Great Again” is taking precedence over fiscal prudence. Although the sweeping tax cuts he’s implemented have boosted economic growth, they’ve also increased the budget deficit. It’s expected to balloon to $804 billion this fiscal year and to $1 trillion by 2020. Deficit spending is inflationary and there is no plan to curtail this.

In addition, gold prices have fallen significantly from the highs they reached in 2011. Back then, investors feared that the eurozone could break up, while even a US debt default was deemed a possibility. Although gold prices have received a boost from President Trump’s recent remarks, gold is still trading at levels significantly below its peak. Politicians like to print money – it buys votes. Once they get the taste for it, they print as much as they can get away with. In contrast, gold sees modest increases in supply – newly mined gold typically increases by around 2% per annum.

Sitting on a gold mine

For those seeking to invest in gold, there are three main routes. Buying (and storing) gold bullion, investing in an exchange traded fund (ETF), or buying shares in gold mining companies. Because of the disadvantages of owning physical gold, we prefer to express our contrarian view on gold through gold mining stocks. Although mining companies can suffer from the inherent risk of on-the-ground mining projects, certain stocks have fallen to more reasonable valuations than has historically been the case, for various reasons. Firstly, gold miners were very overvalued some years back, because they offered investors an accessible way to invest in gold. But in 2004, gold ETFs came along, which offered a new way to access gold in an easy manner. Some gold miners lost the premium they once enjoyed, while suffering the double whammy of falling gold prices. But as contrarian investors, we have been searching for ‘ugly ducklings’ – unloved stocks that have the potential to flourish in the future.

From ugly duckling to golden goose?

One ‘ugly duckling’ we identified is Newcrest Mining, the largest listed gold miner in Australia. Newcrest has faced some problems in the past decade, namely disappointing production, profit warnings and a weakening balance sheet. But Newcrest’s recovery from these setbacks makes it an interesting prospect for the contrarian investor. Management are cutting costs and improving efficiency and the company has restarted dividend payments. Meanwhile, there are plans to expand its Cadia mine in New South Wales. That, plus the development of its Golpu mine in Papua New Guinea, could drive output growth. Of course, we can’t promise that Newcrest will turn from an ugly duckling to a golden goose. But we do think that the company merits a place in our portfolio, as our contrarian view on gold underpins what we consider to be a compelling investment case.

 

Please remember that past performance may not be repeated and is not a guide for future performance. The value of shares and the income from them can go down as well as up as a result of market and currency fluctuations. You may not get back the amount you invest.

The Scottish Investment Trust PLC has a long-term policy of borrowing money to invest in equities in the expectation that this will improve returns for shareholders. However, should markets fall these borrowings would magnify any losses on these investments. This may mean you get back nothing at all.

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