Just as global stockmarkets were beginning to wobble in late 2007, a fund manager told me over lunch that I was wrong to expect a proper crash.
Instead, he said, share prices at that very moment were so cheap that the market was offering me a once-in-a-generation chance to transform my financial future (in a good way). I should take it.
He was completely wrong of course: 2008 saw a full-blown market collapse (which presumably transformed his own future in a bad way). But nonetheless, the phrase “once-in-a-generation chance to transform your financial future” stuck with me. I’ve been on the lookout for such an opportunity ever since.
Given what has happened in the first few trading days of the new year, you may be thinking that 2016 isn’t the year for this kind of thing. It is more likely to be the year when the unsettled scores of the financial crisis come back to haunt markets; when central bankers find they are out of monetary ammunition; and when the post-crisis recovery goes from stall to dive. Best, perhaps, to step back, hoard cash and hope this crash is quicker than the last.
But what if the opportunity this year is in a sector that has already seen prices fall as much as it is possible for them to fall without bankruptcy being a certainty?
A few weeks ago I got an email from one of my favourite City old hands, Peter Bennett of Walker Crips. This century has so far offered only three “major investment gimmes” (things it is perfectly obvious you must do), he says. Those were to sell ahead of the two big crashes and to buy Japan when the Nikkei hit 8,500 (and was stupidly cheap). But number four may be just ahead of us: gold mining shares.
I can hear tittering at the back – particularly as regular readers will know that I have a long-term soft spot for gold. But hear me out. The gold miners have performed abysmally over the past four years. They have underperformed all other sectors and most other commodity stocks. And they have underperformed emerging markets as badly as they did even in their worst days of the late 1990s.
On average they are down about 75%, something that takes them almost back to their lows of the last century and about as far as anything ever goes (the Nasdaq was unusually awful in falling 78%).
This is partly to do with the fall in the price of gold in the last four years. But there’s more to it than that: look back over the last decade and you will see that the while the miners have more than halved, the gold price itself has doubled. The problem is not the gold price, but, as investment strategist Edward Chancellor succinctly puts it, the fact that most gold miners are run by “blithering idiots”.
The industry’s biggest problems are all about management incompetence. Think lousy acquisitions, endlessly awful misallocation of capital and the prevalence of a volume mindset (“let’s mine as much gold as we can, whatever it costs”) over a moneymaking mindset (“let’s dig this stuff up as cheaply as possible so we can sell lots of it on at the highest margin possible”).
Look at the total cash flows for the sector and you will see what I mean. Through all the best years of the great gold bull market they were negative: instead of focusing on how they could create conventional shareholder returns, miner managements were pouring cash into new and increasingly expensive production. The average cost of extracting an ounce of gold from the ground rose from $300 in 2000 to $1,200 in 2012. Fool’s gold, indeed.
In the past you could put most of this idiocy down to the fact that most managers of most gold companies have been gold bugs, say the analysts at Marathon Asset Management. They (like many of their shareholders) want gold not because you can sell it for cash, but for its own “palliative properties” – that way they feel its status as a real asset and a currency in its own right protects them from the coming implosion of the fiat money system. So for them, a gold company should be valued not on how much gold it sells but how much it still has. Think of it as a bit like “owning Procter & Gamble and insisting they produce as much Pantene as possible but hold off actually selling it”.
That’s the bad news. The good news is twofold. First, the capital cycle is doing its job in the gold market. Over the past three years, supply has been falling as high-cost mines have begun to shut down (when the price of gold falls substantially below the cost of extraction, even idiots eventually stop digging). And second, there are hints that the industry is beginning to evolve.
Newcrest – one of the lower-cost producers – has hired a new chief executive who is starting to normalise the way the firm works. He is focused on costs, not ounces, says Marathon – prioritising free cash flows and adjusting management incentives so everyone else does the same. The result is something radical: Newcrest no longer spends more on digging gold out of the ground than it makes on selling that gold.
Price falls of this kind of volume combined with general revulsion for the sector in question, a turn in the capital cycle and a new management competence are exactly the conditions that create great bull markets. So much so that even some of those expecting huge falls in the wider markets are still keen on gold miners.
Marc Faber (author of the cult newsletter Gloom Boom and Doom) reckons that gold mining is one of the very few sectors around – “probably the only one – that could double and treble in price very quickly”, and UBS is looking for it to bottom this quarter too.
Are you left feeling this could be the fourth “gimme”? Me too. I think the best funds in sector are the BlackRock Gold and General and the Tocqueville Gold Fund. Marathon holds Newcrest and Mark Faber is an investor in Barrick. I hold (and am topping up) BlackRock. I also hold the metal itself. The story I’ve told you here isn’t about the metal – it’s about the miners. But if wider stockmarkets crash, if we see a new wave of deflation coming from China and central banks react to that with more money printing and negative interest rates (the only route they think they have), gold at $1,100 is going to look pretty cheap too.
• This article was first published in the Financial Times.