Contrarian Value Investors Are Taking Large Positions In Gold And Miners

In his latest Gold Investment Letter, John Hathaway, Portfolio Manager and Senior Managing Director at Tocqueville Asset Management, writes that chances are high that the bottom is in for precious metals and miners. He admits not being 100% sure, rightly so, as it is impossible to predict a final bottom. The point is that all signs point to a lasting bottom and brewing strength in precious metals.

The most interesting statement in the investor letter, at least in our view, is the observation that tontrarian value investors are entering the precious metals market, both the metals and miners. That is a signficant evolution, and the most important sign of strength. Hathaway explains the rationale behind it:

We observe that many investors who understand, and may well have been deeply committed to the investment rationale for gaining exposure to potential currency debasement, have been scarred by two extremely difficult years of negative performance and are therefore on the sidelines looking for a comfortable point to reenter the sector. In the meantime, we have witnessed the entry of contrarian value investors whose rationale can be summed up as viewing gold mining shares as an inexpensive way to protect capital in the event of a broad correction in equity and capital markets. It seems highly certain to us that the positive returns generated by equity markets over the past two years have represented a substantial barrier for capital to reenter precious metals. We therefore believe that a bear market in equities would constitute a catalyst to drive gold and precious metals equities sharply higher.

Supply and demand continue to be robust. It should translate in higher gold prices going forward. At the supply side, miners are not likely to embark upon news programs of mine construction at current prices. Therefore, Hathaway believes that mine supply will shrink in the years ahead, especially after 2015. This is what he sees in the demand side:

The demand picture, especially from Asian consumers and possible central banks, looks robust. The flow of gold into China continues to set records and the all-important consumption by the Indian subcontinent remains solid. The Chinese government, acutely aware to the downside risks of its $4 trillion exposure to the US currency, has almost certainly been surreptitiously accumulating physical gold as a hedge. Should Western investor demand return following its two year withdrawal, the impact could be explosive in the context of an already tight situation for supply. Since the rationale for a turnabout cannot be articulated and is almost inconceivable in terms of consensus investment views, it seems all the more inevitable. The situation seems to have strong parallels to the 1999 bottom in the gold market.

Hathaway discusses the gold market structure which he believes is likely to change in 2014:

We believe that the architecture of the gold market is set to undergo significant change in the current year and that these changes, which have little to do with macroeconomic considerations, will result in attracting capital flows. These changes begin with inquiries by regulatory authorities in Germany and the UK into possible price manipulation by bullion banks in connection with the London Fix mechanism for gold. These inquiries have been followed by lawsuits seeking damages for plaintiffs possibly injured by price manipulation. We believe many other lawsuits could follow. These in turn would lead to a process of discovery, daylighting the practices of bullion banking. Suspicion of market manipulation and collusive practices has been widespread for many years, and the enlistment of regulatory and legal resources to uncover these possibilities is, in our opinion, constructive.

Last but not least, gold mining companies, in response to the difficult conditions of the past two years, have cut costs and committed to returning capital to shareholders.

There has been wide scale replacement of senior managements in response to shareholder dissatisfaction with poor performance, disrespect for financial discipline, and disregard for shareholder interests. Many of the new class of CEO’s have taken an oath to refrain from high risk capital programs that in the past have led to serious dilution of shareholder interests. Even a modest rise in gold prices would result in free cash generation that will in our opinion surprise investors favorably.

Gold Monitor – 50 gold related charts for Q1 2014

From his gold monitor, a collection of 50 charts directly and indirectly related to gold, we have picked out the ones we believe are showing a significant trend. The full document is embedded below.

Real rates in US and Europe versus the gold price in dollars and euros:

real_rates_vs_gold_price_Q1_2014

 

Central bank balance sheets for the major Western economies (left) and M2 in the US vs the gold price:
money_supply_M2_vs_gold_price_Q1_2014

 

Sentiment towards gold clearly came off a bottom in Q1 2014:

 

sentiment_public_gold_Q1_2014

 

 

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