Managers put less stock in gold
Resources plays: Even the bulls see better valuations in other commodities
By Rudy Luukko
National Post
Monday, July 15, 2002
For most of this year, gold stocks have gleamed amid scandal-smeared markets, and generally speaking, the more bullish on bullion resources managers have been, the better their funds performed.
After five consecutive months of gains, the gold sector's winning streak came to an end. The category most affected was precious metals, with the average fund off 10.1% in June. Broadly based resources funds with significant gold exposure also felt the impact.
Less affected were managers who have been locking in gains on gold stocks and redeploying the assets to other resource segments where valuations appeared more attractive.
Fred Sturm of Mackenzie Financial Corp. is among that group. "Many of the share prices already reflect gold at US$400. So valuation risk has crept into the gold sector," says the manager of Mackenzie Universal Canadian Resource Fund and Mackenzie Universal Precious Metals Fund.
His recent reduction in exposure to gold in the resources fund -- he had an overweight position last year -- came despite his belief bullion will go higher yet. Mr. Sturm is concerned about the prospect of new supplies. In the next year, he expects the price of gold to rise to US$340 to US$350, up from a recent close of US$314.70 in New York. "That's a level at which new mines will be developed again."
Rory Ronan, co-manager of Trimark Canadian Resources Fund, also is cutting back on exposure to precious metals. "The valuations of gold companies have always been on the expensive side," and now is no exception, he says.
He is prepared to start buying gold stocks again if share prices weaken sufficiently to meet his valuation targets. Mr. Ronan expects the price of bullion to rise to at least US$350, eventually.
He also lauds the low correlation of gold stocks with other sectors. "It's a great diversifier in the portfolio. There are so many days when my gold stocks will be up, and everything else will be down, and vice versa."
There are managers who remain bullish on the gold sector, though. John Embry, manager of Royal Precious Metals Fund believes there is a scarcity of good gold stocks, and these are still worth buying even if they are pricey.
"They are reflecting considerably higher prices than we are seeing currently. But that doesn't bother me," says Mr. Embry, who is overweighting golds in Royal Global Resources Sector, too.
He expects bullion to be between US$350 and US$400 during the next 12 months. The positives, he says, are a decline in supply, growing demand, a reduction in gold lending by central banks, less hedging by gold producers, the falling U.S. dollar and generally poor stock markets.
Another prominent resources manager who remains positive on gold stocks is Kevin Nyysola, manager of the the largest natural resources fund, the $302-million Investors Canadian Resource Fund.
"I have right now the largest gold and precious metals weighting that I have ever had," says Mr. Nyysola, who has managed the fund since its inception in 1996.
His fund generally has a bias toward large-cap companies with the flexibility to shut down their least profitable operations.
The reduced hedging by leading producers is a secular change in the gold sector, he says. "There's something new in the gold market that hasn't been there for years."
There is another very old rationale for gold that is driving it higher, notes Bob Lyon, manager of Signature Canadian Resource Fund. That is the rediscovery on the part of investors that gold is a cheap insurance policy and acts as a store of value in difficult times.
"Gold has really done the job it has done for 2,000 years by protecting peoples' assets when they need it the most," says Mr. Lyon, who is slightly overweight in gold stocks. "It's dangerous to be underweight the gold sector as a money manager right now."
Although golds have been by far the most impressive this year, the more economically sensitive resources sectors are likely to benefit the most when the global economy recovers. Mackenzie's Mr. Sturm says the macroeconomic outlook is for increasing demand for commodities such as oil and gas and base metals. "Current valuations suggest there are still attractive returns to look forward to."
This is all the more so since the resources sector -- as managers put it -- have been "starved of capital" in recent years. "Because of the tech bubble in the late 1990s, the amount of capital that would normally have been invested in the resources sector hasn't been put there," Mr. Nyysola says.
While investors were shunning resource stocks, the pressure on the companies to perform became immense, Mr. Lyon of C.I. Fund Management says. He believes consolidation and cost-cutting has left resources firms well positioned for an economic recovery. "As investors have taken a back-to-basics approach, suddenly these stocks look fairly attractive."
On a cautionary note, money managers warn that oil prices are higher than what would normally be expected under current supply-demand conditions. The reason: the conflict-ridden Middle East and the possibility of a U.S. assault on Iraq.
"The uncertainty is keeping the oil price higher than it would otherwise be," Mr. Lyon says. On the bright side, he adds, prices of energy stocks are assuming oil prices of about $21, rather than the current $27 range. "The equity market has been quite rational."
Mr. Sturm, who has been increasing his energy exposure while reducing golds, says stock-price-to-cash levels are relatively low. During the past decade, this valuation multiple for the industry as a whole has been as high as nine times, he says, noting: "We see many opportunities to invest at below four times today."
Still, money managers need to be selective in the energy patch. "I don't think that as a sector it's a screaming buy," says Mr. Lyon, who likes asset-rich junior firms such as Canadian 88 Energy Corp. and Navigo Energy Inc. "You have to look for the companies that can grow their production."
Mr. Ronan lists drilling contractor Ensign Resource Service Group Inc. as one of his favourite energy picks for the Trimark fund. He cites its high return on equity and lack of debt. "The drilling business in general is a very good free-cash-flow business," he says.
Mr. Ronan's greatest overweighting in the resources sector is in base metals. Mining companies have become far more conservative because of the lack of capital in the past five years, he says. Consequently, "very little supply is coming on in the next few years," which has positive implications for base metals prices.
Mr. Ronan's recent largest holding among 45 names in his fund is Inmet Mining Corp., mainly a copper producer, which he likes because of its increasing earnings and cash flow and "positive corporate developments."
Another favourite is Aur Resources Inc., which he describes as a "pure copper play" that has been increasing earnings as well as cutting costs. "It's a good way to play a cyclical recovery," he says.
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