The rotation to value and where it leaves gold stocks

In an extraordinary year, November was another remarkable month. The FTSE/JSE All Share Index gained 10.5% as markets around the world bounced.

Significantly, there was a different look to this surge. It was not driven by the same growth stocks that had led the market recovery for most of the year but rather depressed counters like local banks.

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News of successful vaccine trials has raised the possibility of a strong economic recovery. That has led investors to look differently at ‘value’ stocks.

‘This year marks pretty much the worst global growth in living memory,’ said Peter Brooke, co-manager of the Old Mutual Flexible fund. ‘Therefore, next year will be a big recovery from that. That is almost set in stone. And with the vaccines coming through, the risk of a depression is reduced.’

Best and worst

How companies perform in this recovery, however, will be uneven, just as their performance during the recession has been.

‘What you should expect is that those companies that did worst in the recession, and particularly through lockdown restrictions, will have the biggest recovery,’ Brooke said.

‘That doesn’t mean that they go back to their previous levels. And it doesn’t’ mean that global technology companies aren’t still going to grow and aren’t amazing businesses. But the sheer extent of the recovery, we think, will give a boost to those pockets of the market that have suffered the worst.

‘What that means is that higher risk, cheaper companies will have a big rebound in earnings, and they have a low base to grow from. At the same time, high-quality, high-growth companies whose multiples are very expanded already have a high base that is harder to grow from.’

Rotation

This is not, Brooke emphasises, a longer-term structural change. It is likely to be a one-year rather than a five-year story.

‘The truth is that the short-term environment for these value companies is improving much more than for the tech companies,’ said Brooke. ‘So, the theme is getting better and the price is attractive, and that’s why we think it’s appropriate to position more towards value.

‘It’s not just that one is cheap and one is expensive. That is always the case. But they are extremely cheap and extremely expensive, and as we get relaxation of lockdowns, the environment for sectors like consumer discretionary and hospitality stocks will be much better.’

Gold miners

This potential rotation also creates a different narrative around gold mining stocks that were initially such stellar performers in the market recovery.

AngloGold Ashanti, for instance, climbed 130% between mid-March and the end of July. It has, however, since given up most of those gains.

As Truffle Asset Management’s Iain Power noted, the gold price was driven up this year for a number of reasons – low interest rates, the extent of global debt, the scale of monetary stimulus, and uncertainty around the global economy. In this environment, with US Treasuries are offering negative real yields, gold became an obvious alternative safe-haven asset.

Most of those structural factors are still in place. However, what has changed with the announcements about vaccine development is that fears around the global economy have subsided.

Valuations

‘That particular driver is changing and instead of a tailwind for gold is potentially becoming a headwind to the extent that people who were holding gold for its uncorrelated and hedging characteristics are perhaps getting less concerned about whether we will ever get back to where we were,’ said Power (pictured), who co-manages the Truffle SCI Flexible fund.

‘That is the one factor which we think is resulting in some of those holders of the metal liquidating some of their positions.’

The gold price has therefore come off its highs. However, this is not the only consideration when looking at local gold stocks. The valuations of the shares themselves also come into play, and these counters have been cheap.

‘We like to think of gold shares is as a way of ensuring the portfolio against tail risks, because gold behaves counter-cyclically to many other assets,’ said Power. ‘And because gold miners have been cheap, it means that you are not paying a lot for that insurance.’

Truffle’s funds have benefited as these shares have re-rated. However, in recent months, it has sold out of most of its gold positions and now holds only a little exposure to AngloGold Ashanti.

Longer term

‘Gold shares, over time, have never been good investments,’ said Power. ‘It’s never paid you to buy and hold gold shares. It is more of a shorter-term protection strategy that one has to view in conjunction with the underlying valuations of those businesses.

‘We certainly did have bigger gold positions in our funds in the last three years, but we have taken profits,’ he added. ‘Over the longer term, we can certainly see why the gold price might drift higher again, but I think the Covid pandemic-related risks that were perhaps driving it are likely to recede, and now the drivers for gold are likely to be weak dollar and continued fiscal stimulus.’

Brooke agrees that, despite their cyclical nature, gold shares are not where he is looking for value now.

‘Gold typically doesn’t fit well into this story,’ said Brooke. ‘It wouldn’t be the emphasis of what I would be talking about at all, which in South Africa is around the opportunity in some of our bombed out industrial companies.’

Patrick Cairns is South Africa Editor at Citywire, which provides insight and information for professional investors globally.

This article was first published on Citywire South Africa here, and republished with permission.

Source: moneyweb.co.za