When the Smartest People in the Room Get it Wrong

For reasons ranging from time and temperament to financial acumen, many retail investors choose to allow the professionals – the “smartest people in the room” to manage their money. Why endure the pain of picking your own stocks when you can get a wizard at stock picking to do it for you?

In the UK, retail investors jumped at the chance to invest in the launch of the Woodford Equity Income fund, the brainchild of renowned UK stock-picker turned fund manager Neal Woodford.

Within five years of its 2014 launch, the fund suspended trading due to excessive withdrawals, leaving investors trapped in limbo. Woodford was considered by some to be “Britain’s answer to legendary investor Warren Buffett.”

The following price performance chart is from an 8 June article appearing in the UK Guardian entitled Bright star to black hole: the rise and fall of fund manager Neil Woodford.

Even the smartest people in the room can get it wrong. In theory, selecting a fund of any kind should require the same kind of “due diligence” as picking an individual stock. Yet far too many investors simply rely on past performance, industry awards like Fund Manager of the Year, or opinions from prominent market experts appearing on financial websites to select a fund in which to invest.

Common sense suggests potential investors should approach the decision of where to invest with the same kind of healthy skepticism typical in approaching any major financial decision. One does not buy a house without checking the foundation and the major systems.

Much of the information investors sort through in the due diligence process is slanted to a degree towards the most favorable interpretation of the company’s prospects. In addition, information can be directed more toward investors operating with one investing strategy than those following a different investing approach.

Gold is a classic example. Since the trading year 2019 began we have seen a rising number of articles reminding us that gold is a hedge against troubled times. Given the current trade war between the US and China; the prospects of additional trade skirmishes between the US and India and now Viet Nam; and the potential for a shooting war between the US and Iran, we certainly could be in for troubled times.

The gold as a hedge advice has special appeal for momentum or trend traders – investors looking to catch a wave and ride it, hopefully bailing out with a profit before the wave crashes.

While some long-term, buy and hold investors might scoff at the idea of buying gold now, another, perhaps more appropriate question, might be why haven’t I been buying gold in the past? Followers of the precious metal know of multiple times over the past decade when the smartest people predicted declining fortunes for the long-term future of gold. Did they get it right?

There are four ways to invest in gold.

The first is to buy physical gold bullion (bars or coins) with the most convenient method being the multiple online dealers and even auction sites. Here is how the price of gold has performed over the last decade, in US dollars.

The second method is to buy shares in a gold Exchange Traded Fund (ETF) that buys and stores physical gold. The most popular gold ETF is US-based SPDR Gold Trust (GLD). There is an Australian ETF – ETFS Physical Gold (GOLD.AX) – available in Australian dollars, giving that ETF – GOLD – a slight boost from the exchange rate. Here is the 10-year performance of the two compared.

Examining the chart for the decade shows both an attractive long-term yield as well as multiple opportunities for trend or momentum trading.

The third way is to buy an ETF that tracks the performance of gold miners around the world. The most popular gold miner ETF is the VanEck Vectors Gold Miners (GDX).

ETF’s have become very attractive investment vehicles for retail investors, but common sense and basic math suggest the performance of multiple stocks averaged together will pull down the performance of the high achievers. The following chart compares the performance of the basket of gold miners in the GDX against the price of GLD.

Although the price of both move in harmony, the GLD price – which invests in a single commodity – has outperformed the GDX – which invests in multiple miners.

The fourth way is to invest the time and effort to find some top-performing individual mining stocks. The following chart looks at the 10-year performance one of the top miners on the ASX – Evolution Mining (EVN) – against the GLD.

In terms of stock price movement, the most successful miner on the ASX has been Northern Star Resources. The company’s shares were trading at $0.03 per share back in early 2010 when Northern Star began to grow. It now trades at $11.65. Here is a five-year chart – the average holding period for many long-term investors – for the GLD and the top three ASX miners, adding NST (Northern Star).

The opportunities for momentum traders appear obvious, but one must wonder why long-term investors would follow the advice to avoid falling gold prices when the decades long trend appears rising. While the smart people may have gotten in right some of the time, the overall performance of the gold miners might make some retail investors ask themselves why they are not picking their own stocks.

Gold hit a six-year high a few days ago and multiple analysts are rushing into the arena to speculate on how high gold will go. The top tier Australian miners have an advantage of a weak AUD against the USD. Operating costs are in AUD and they are paid in USD.

Common sense would once again suggest while gold miners appear to be solid prospects, not all miners are the same. Far too many retail investors are addicted to the “ten-bagger” aspiration espoused by legendary US investor Peter Lynch. A ten bagger is a stock that increases ten-fold over the initial investment and when coupled with the adage that big company stocks don’t make big moves, steers retail investors into a natural bias towards start-up or early stage stocks.

In the heyday of the mining boom retail investors in droves were joyfully investing in junior miners, some with little more than applications for exploration licenses. A less euphoric but more common sensical approach would be to stick to miners with existing operating and profitable mines and exploration for new assets underway.

When the price of gold began to fall in the early years of this decade the big miners like Newcrest got caught with high operating costs and more exploration assets than they could deal with under changing conditions. So, these giant global gold miners operating in Australia began a fire sale of underdeveloped assets. Enter smaller miners like Evolution and most notably Northern Star to expand their assets.

Newcrest Mining (NCM) is by far the largest gold miner we have, with operations here in Australia in the Cadia valley and Telfir with additional mines in Papua New Guinea and Indonesia. Newcrest has another mine in advanced stages of development in PNG and another in Fiji. The company also has multiple joint venture exploration projects underway in Africa and Central America.

Despite its phenomenal average annual rates of shareholder return, Northern Star Resources (NST) appears ready to continue to reward its shareholders. The company has turned in excellent earnings growth over five and ten years and according to analyst estimates there is more to come. The company took off when it acquired the Paulsen’s mine in 2010 and now operates three concentrated mining centres primarily in Western Australia with a newly acquired operation in the US state of Alaska, with plans to expand in that mining region. Northern Star is classed as a low-cost producer, with All in Sustaining Costs (ASIC) averaging between AUD$1100 and $1200 per ounce.

In the past week, Evolution Mining joined both Newcrest and Northern Star in posting new 52-week highs. Trend traders generally see new highs as a positive indicator of better things to come. The company has six gold operations across the states of Queensland, NSW, and Western Australia, with two exploration projects in the pipeline.

While the global investing community remains watchful of a wall of worry, the price of gold and the price of gold miner stocks will have strong tailwinds at their backs. In short, most ASX gold miners with anything positive about them will get a bump. However, investors who lived through the collapse of the boom in iron ore mining and the subsequent challenges facing many junior iron ore miners may be well advised to stick with junior gold miners with actual earnings potential.

The last two stocks in the table qualify with solid analyst earnings growth estimates over the next two years.

Golden Road Resources (GOR) has yet to show a profit, but its Gruyere Gold Project in Western Australia is expected to produce between 170,000 and 230,000 ounces of gold in 2019. What is attracting investors is the fact the Gruyere is a Tier 1 Project. Criteria for Tier 1 mines include mine life in excess of 10 years; reserve estimates greater than 3.5 million ounces of ore; annual production of more than 300,000 ounces at the lower end of the cost curve.

Alacer Gold (AQG) is incorporated in Canada, but headquartered in the US with listings on both the TSX and the ASX. The company has 80% ownership of a producing mine in Turkey with ambitious plans for expansion there. The mine produces both gold oxide and gold sulphite with on- site processing plants for both. The plant for processing gold sulphite was completed in late 2018 with its first commercial production coming on on 31 May. Brokers are bullish on the sulphite potential from Alacer. UBS maintainted its BUY recommendation on AQG followinht the news of the sulphite processing plant and raqised its price target to $4.90.The company has a new deposit expected to come online in two to three years