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Monday, 9th November 2020 07:29 - by David Harbage
The first week of November produced a slow burning fuse rather than bright fireworks insofar as the US election is concerned. At the time of writing this blog, it would appear that the Democratic party have accumulated more electoral college votes than the Republicans and therefore Joe Biden is set to replace Donald Trump as President in January. However, while counting has yet to be concluded, the incumbent appears set to challenge the validity of the postal votes in the Supreme Court thereby ensuring uncertainty continues for another week or so.
In any event, financial markets have been quite sanguine about the election results as the Democrats do not seem to have achieved a clean sweep across the political landscape. The S&P500 index, probably the best metric of America’s quoted companies, advanced 7% this week - from 3270 to 3505, to recover the ground lost over the previous fortnight. In particular, it would currently appear that Congress will retain sufficient Republican or independent representation as to be able to limit a Democratic agenda - which includes higher corporate taxes and the prospect of the largest (technology-oriented) companies being broken up in order to ease monopolistic market conditions.
At the risk of making the reader yawn by raising the subject, another key investor uncertainty surrounds the prospect of a trading deal being agreed between the British government and the European Union. There will be heightened noise in the media on political issues for the next couple of months – both of which should be resolved by the end of July, most probably seeing Mr Biden as the 46th President of the USA, together with the UK and the EU having reached an agreement of sorts over Brexit. Once these short term uncertainties have been determined, (notwithstanding that both of these will have significant medium term implications for the world’s most developed economies), the investment community can focus on the biggest issue: Covid-19.
Unlike many politicians response to the pandemic, the headline performance of equity indices, especially on Wall Street, remains surprisingly resilient. Most would struggle to believe that the US equity market could be 10% higher than its starting point, if they had been told at the beginning of the year that 2020 would deliver a coronavirus pandemic, economic shutdown and an election impasse in the US. Whisper it quietly (because this is an industry heresy), but have markets got it right – in their current fulsome rating - or is the valuation currently placed on stock exchange listed companies wrong?
The so-called second wave of Covid infection appears, despite suggestions of further mutation, to be less life-threatening in the developed world than that experienced in the earlier March-April peak. However, governments’ decision to shut down large parts of the economy will mean that the damage to businesses and livelihoods increases, as will the potential less visible strain on the world’s financial structure and systems. As regards the latter, higher support for the furloughed and unemployed, for businesses and for the health sector means that the public sector’s balance sheet – both at home in the UK, or across the world at large – looks ever more fragile.
Running with a fiscal deficit is possible while the cost of servicing such indebtedness is low, but any pick-up in interest rates or inflation could prompt a collapse. Because most of the world’s major financial centres are experiencing very similar financial and economic conditions, an obvious ‘run’ on any one leading currency has not emerged; but, with every extension of government support, the ‘dam’ becomes increasingly ‘full and closer to bursting’. UK public sector net debt – currently north of £2 trillion and set to increase by between £250billion and $350billion in the current financial year – exceeds the nation’s annual gross domestic product (GDP) or total worth of all it produces including services. Whist ostensibly apolitical, the pressure on the Bank of England’s MPC (Monetary Policy Committee) to keep rates low – if not negative – is obvious.
Central banks’ huge injections of capital must logically find one or more asset ‘homes’ to occupy and, with overnight rates and bond yields offering very little, the prospect of this cash ultimately finding its way into risk assets – such as property and equity – is high. However, there will undoubtedly be a lot of corporate casualties before investors can relax their guard; certainly size in itself will not provide safety. With governments imposing strict travel and quarantine rules, the balance sheets of high profile domestic names exposed to aviation, like easyJet, British Airways’ owner International Consolidated Airlines Group and Rolls Royce, have suffered. Many businesses have bolstered their finances with cash-raising exercises – some of these rights issues appear as ‘rescue’ funds, but others seem more opportunistic as they could enable the purchase of competitors or other complimentary firms at distressed prices.
Investors must be rigorous in carrying out due diligence on prospective stock exchange investments, paying close attention to the financial metrics (notably cash position and flows) in an environment of interrupted revenue to determine the survivors. Beyond that, making a judgement on how a particular industry will operate in a world that has changed, post Covid-19, is key. Previous blogs have referred to the new internet-facilitated age where a number of traditional commercial activities may be replaced by digital businesses. Estimating when some semblance of normality, returns will be critical – a number of consumer-facing sectors, including hospitality and travel, immediately come to mind – as investors will then have the testing task of choosing between owning premium priced, growth stocks and lowly valued, neglected shares. The former are likely to feature ‘new world’ businesses, along with those that have been resilient – probably because they are less economically sensitive, such as utilities and food manufacturers – while the latter will include firms offering potential recovery.
According to one’s perspective on the duration of the pandemic or, more materially, the magnitude of the economic shutdown – and the extent to which a prospective investor wishes to accommodate shorter term expectations – a decision to defer the purchase of equity may be made. The writer retains a pessimistic view in the short term and, while retaining an interest in stock market investments – typically by favouring cautiously, but actively, managed collectives such as Diverse Income and Scottish investment trusts - would prefer to keep ‘powder dry’ for an opportunity to purchase equity at a lower price. Given ever higher issuance of new money by central banks in response to governments’ borrowing to support economies, placing some of that reserve ‘powder’ in gold may – in view of its limited supply, historic safe haven status - appeal.
Besides physical gold, which can be replicated via exchange commodity funds (ETCs), owning the companies who possess and extract the precious resources represents another route – albeit a more geared, higher risk-reward way, given that these are corporate entities - to benefitting from the possibility of a higher gold price. Probably the most reliable means of taking a stake in the world’s gold miners would be via an exchange traded fund such as the i shares Gold Producers ETF which currently owns the world’s 54 largest gold miners as it endeavours to replicate the S&P Commodity Producers Gold index. The ETF’s total expense ratio is 0.55% per annum and a breakdown of where its stock exchange constituents are listed reveals: Canada 54%, Australia 14%, US 13% and South Africa 10%.
Higher risk-reward options include actively managed precious metal funds such as the £1.78bn Blackrock Gold & General open ended fund – which invests in the world’s largest gold miners, and is similarly concentrated as the above mentioned ETF (its top ten holdings account for half of its portfolio) – or the Golden Prospects investment trust. The latter invests in smaller and medium sized gold, silver and precious metal companies (typically less mature with 65% of its portfolio being producers and 35% developers or explorers). Relatively small, with assets of just £43m and an annual management fee of 1.25%, its top ten holdings account for 60% of its portfolio worth and the share price currently stands at a 25% discount to net asset value.
Drilling down (please excuse the pun) beyond these collective investments, readers might be interested in individual gold miners. Based on market capitalisation in excess of £150bn each, and each equating to 10% of the world’s listed gold mining corporations are Newmont and Barrick Gold – which feature in the previously mentioned Scottish investment trust incidentally, as well as in the i shares Gold Producers ETF and the Blackrock Gold & General fund. Barrick Gold was the subject of a US$564m purchase in August from renowned investor Warren Buffet – who previously had little appetite for the shiny metal or gold shares.
Asked to suggest a couple of smaller UK listed gold mining companies which might interest our readers, the existing gold and copper producer Anglo Asian Mining and the less mature explorer-developer Pure Gold merit further research. Azerbijan-based, AIM-listed, £140m market cap Anglo Asian has been extracting gold since 2009 and has 10 years’ mine life. Forecast to deliver 70k ozs at a cost of $634 per oz this year, financial metrics are strong: brokers expect net cash of $40m and earnings per share of 19p (equates to a PE ratio of 6.7x) next year.
While geo-political concerns in the region (the recent conflict with Armenia captured global headlines) very largely explains the low valuation of Anglo Asian Mining, Red Lake, Ontario based £600m capitalised Pure Gold has also encountered an existential threat - in the form of forest fires - just three months ago. Pitching itself as Canada’s next gold mine, Pure possesses exceptionally high grade resources and has impressive investor backing (includes Eric Sprott, miners Newmont and Anglogold Ashanti and is the second largest holding in the Golden Prospects investment trust portfolio. Due to pour its first gold next month, phase one of its development aims to produce 1m ounces at a cost of less than $800 per oz. As ever, these are not personal or specific recommendations and the author would encourage readers to carry out their own due diligence.
The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.