Tocqueville Gold 2010 Year-End Investor Letter
December 2010
Two significant developments boosted the gold price in 2010. First the Greek debt crisis in the
spring contributed to doubts as to the safety of the euro. In our opinion, many investors who
took refuge in the euro to escape from the U.S. dollar learned a tough lesson----that no paper
currency deserves safe haven status. As investors dumped their euro holdings, the dollar
appreciated and gave the appearance of strength. Dollar strength has usually been associated
with a weak gold price. However, in this instance, the gold price rallied in both in U.S. dollar
and euro terms. More important, gold broke out to an all time high in euro terms. As a side
note, it is remarkable but unsurprising that the European sovereign debt crisis remains
unresolved. At the moment, finance ministers in Europe are scrambling to rescue Ireland, while
spreads for Greek sovereign debt have widened to levels that exceed those when Greece was
front page news in May. In our opinion, permanent resolution of the credit woes afflicting the
weaker European economies (PIIGS-Portugal, Italy, Ireland, Greece, and Spain) will remain
elusive. Bailouts and rescues resolve nothing and have only bought time while potentially
fueling inflation by further undermining confidence in the euro.
The second key development was the launch of a second round of quantitative easing (QE2) by
the Federal Reserve. While economists debate whether additional money printing by the Fed
was necessary or will have a positive effect on economic activity, the rationale put forth by
Chairman Bernanke and other Fed officials was quite disturbing to foreign holders of U.S.
dollars. That rationale unequivocally stated that the purpose of QE2 was to create inflation.
Such statements coincided with a new upward leg in the gold price, which rose from $1,308.35
at the end of September to an all time high of $1,431.25 on December 7, 2010. On the day after
the Fed officially announced that it would proceed with QE2, the gold price rallied 3% in a
single day. The action was met with a storm of criticism from academia, former Fed officials,
and ministries of our trading partners claiming Fed actions would result in dollar debasement.
While many observers feel that the gold rally has been overdone, is too crowded, resembles a
bubble or whatever, the simple fact remains that central banks of the Western democracies
appear on course to debase paper currencies. On the one hand, currency debasement is the path
of least resistance to grapple with the seemingly intractable fiscal issues of record deficits and
unchecked growth in entitlements. On the other hand, persistent economic weakness translates
into political pressure for central banks to pursue extremely lax monetary policies. Under these
circumstances, it is hard to argue against the notion that some exposure to gold offers protection
against monetary damage still to come.
Our Tocqueville Gold investment strategy remains consistent with practices since the inception
date of June 1998. Our research team has travelled over 500,000 miles since 2003, to remote
sites around the world to visit the mining and exploration activities of smaller companies. We
seek to invest in companies at an early stage of development which can generate growth through
exploration success or new mine construction. In this way, we have invested earlier than most of
our peers and well before investment banks and brokerage firms commenced research coverage.
This strategy is reflected in the fact that our average market cap is 60% of our peer group
average. It is also exhibited in our low turnover of less than 10% in 2010. The success of our
approach is manifest in having numerous acquisitions of our positions by large cap mining
companies. Two notable examples of this in the past year were the acquisition of Red Back by
Kinross and the acquisition of Andean Resources by Goldcorp.
We believe that mining stocks remain cheap relative to gold bullion. As evidence, we point to
the chart below which depicts our benchmark, the XAU Index, as a fraction of the gold price. At
its current level of 16%, it remains well below its historical norm of 20%-25%. What investors
seem to be forgetting is that the business of producing gold has suddenly become quite healthy,
unlike the lean years leading up to 2008. This is reflected in strong earnings reports, much
improved returns on capital, and a multitude of dividend increases. Unlike gold bullion,
successful gold mining companies are capable of generating internal growth, returning capital to
shareholders in the form of dividends, and participating in potentially accretive merger activity.
We believe that investment in gold mining shares, given the current level of profitability, is
capable of producing acceptable investment returns even if the price of gold were to
hypothetically remain range bound for a period of a few years. |
