This column is part of a new collection of our “Structure Matters” series of interviews with leading ETF and index industry figures. They are conducted by Dan Weiskopf, a portfolio manager at New York-based Access ETF Solutions LLC. In today’s piece, Weiskopf interviews Joe Foster, who is a gold strategist and portfolio manager at Van Eck Global, the firm behind the large-cap gold mining ETF Market Vectors Gold Miners (GDX | C-78) and the Market Vectors Junior Gold Miners ETF (GDXJ | C-48).
Given Foster’s expertise as the firm’s active gold mining mutual fund portfolio manager, we thought it would be valuable to sit down with him regarding what factors might be a catalyst to drive gold mining stocks.
Dan Weiskopf: In the short and long term, what factors should investors be looking for as catalysts for small- and large-cap mining companies?
Joe Foster: Historically, gold stock indexes have had a high correlation with gold. Therefore, movement in the gold price is the primary driver of gold stocks. The price of gold bullion is driven by risks to the global financial system, and especially the U.S. financial system.
Gold has been in a bear market since 2011. This sector is out of favor and most of the selling pressure has probably run its course. As we believe gold is forming a base in the $1,150-$,1300 range, we look forward to catalysts that might increase financial risk and drive gold higher.
In the near term, the anticipated Federal Reserve rate action could prove a turning point for gold, as well as other markets. Will the Fed have the conviction to raise rates? Can the U.S. and global economies withstand a rising-rate environment? In the longer term, we believe the radical fiscal and monetary policies of the past decade could bring unintended consequences.
Global imbalances brought on by quantitative easing, ultra-low interest rates and massive accumulations of sovereign debt, in my view, have the potential to create dangerous asset bubbles and misallocations of wealth. The current U.S. expansion is six years old, and no previous expansion has lasted longer than 9.5 years. Perhaps the next downturn will expose these embedded financial risks.
Weiskopf: Could this sector be considered reasonably valued over historic metrics? What are those metrics? Should we be looking for more consolidation in the group of stocks you follow?
Foster: Gold stocks are undervalued by historic metrics. Price to cash flow and price to net asset value (“NAV”) are the most commonly used valuation metrics, and both show stocks below long-term averages. Gold stock/gold ratios are also at or near all-time lows. (NAV values companies using discounted cash flow methodology.)
Mergers and acquisitions activity is an ongoing feature of the gold sector. Companies combine to gain financial strength or operating synergy. Producers generally look to smaller companies to sustain their production. I think consolidation will proceed at the same pace we have seen during the past couple of years. It could pick up once the current gold price gets moving higher and if valuations move to more normal levels.
Weiskopf: Can you put into context how you view the order of the factors that might drive price performance for your sector?
Foster: The price of gold is the primary driver, as I said earlier. Financial stress, or “tail risk,” are significant drivers, and this can come from many places—inflation, deflation, currency turmoil, banking problems, etc.
Anything that places undue stress on the financial system can be a catalyst for gold and gold stocks. There is a strong negative correlation between the U.S. dollar and gold, so gold usually has a tough time when the dollar is gaining.
Other supply/demand factors that generally influence gold are physical demand (mainly from Asia), central bank demand, scrap supply and mine supply.
All of these factors have been supportive and are helping gold to form a base. Physical demand from India and China has been firm. Central banks have been net buyers for several years. Scrap supply is down and mine supply is expected to peak by 2016.