Two months ago, when gold prices were on the rise, I had a conversation with Kristoffer Inton, director of equity research for basic materials, at Morningstar.
He said something that really gripped by attention. The current gold price is propped by investor demand—gold held in ETFs is at an all-time high. This is risky because today’s investment demand is tomorrow’s recycled supply when investors decide to pivot away from the safe-haven investment towards other investments.
Which brings me to a very pertinent question. As a valuation-driven investor, how must I value gold? Normally, one would buy assets that are demonstrably below a reasonable estimate of their fair value and enjoy the benefits of long-term cashflow generation.
What is gold actually worth?
I reached out to Dan Kemp, Morningstar Investment Management’s CIO, EMEA. He was quick to assert that he does not consider gold to be an investment asset. “An investment asset is one which generates a positive cashflow to the owner and hence can be ascribed a ‘fair value’ through fundamental analysis. Prices move above or below this fair value in the short term. But over the long term, prices tend to move towards it providing a consistent measure against which its current attractiveness can be judged,” he explained. I get the point. There is no fair value to serve as a base to enable an investor make a buy or sell decision. At which price do you determine that gold is undervalued or overvalued? To add to it, gold generates a negative cashflow. Should you buy actual bullion, you need to pay for storage (like a bank locker) and insurance. Or, as Dan Kemp reminded me, the cost could also be due to the opportunity cost of lost income (interest if the value was held in a bank deposit or bond, or rent if it was commercial real estate). This reminds me of a quote by Warren Buffett that neatly encapsulates the views of Kristoffer and Dan.
Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn’t produce anything.
In a Fortune article in 2012, Buffett tackled the subject of gold as an investment. He first categorised investments:
- Currency based investments
- Investments in productive assets (businesses, farms, real estate)
- Investments in assets that will never produce anything (art, gold, tulip mania in the 17th century)
So why are non-productive assets purchased? With the buyer’s hope that someone else will pay more for them in the future.
This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce — it will remain lifeless forever — but rather by the belief that others will desire it even more avidly in the future.
Gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. If you own one ounce of gold for an eternity, you will still own one ounce at its end.
What motivates most gold purchasers is their belief that the ranks of the fearful will grow. Beyond that, the rising price generates additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth — for a while. Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. At $1,750/ounce — gold’s price as I write this in 2012 — its value would be about $9.6 trillion.
Call this cube A.
Let’s now create pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge).
Can you imagine an investor with $9.6 trillion selecting cube A over pile B?
Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers — whether jewellery and industrial users, frightened individuals, or speculators — must continually absorb this additional supply to merely maintain an equilibrium at present prices.
A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops — and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.
Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of cube A will compound over the century at a rate far inferior to that achieved by pile B.
As mentioned above in the article written by Warren Buffet, the price of gold early 2012 was $1,750/ounce; it is now around $1,683.
So what is the reason people narrow down on gold? Dhaval Kapadia, Director and Portfolio Specialist for Morningstar Investment Adviser India, looks at the most common reasons.
-Hedge against inflation: Traditionally gold has been viewed as a hedge against inflation and significant economic and financial market uncertainty. Currently, inflation isn’t a concern in most major markets and hence it’s role as an inflation hedge is limited. Hedge against depreciation
-Hedge against depreciation: Gold can act as a currency hedge. The price of gold is determined in international markets in foreign currency and converted to the price offered in domestic markets. Other things remaining the same, if the local currency depreciates vs the US dollar, the price of gold in the domestic market would rise.
-Interest rates: Gold tends to perform well in low interest rate scenarios as the cost of carry is low.
Summing it up
While there are undoubtedly periods when gold performs very well and its inclusion would benefit the short-term returns of a portfolio, these periods tend to be unpredictable due to the lack of the fair value anchor.
Individuals have various claims as to why gold must be part of the portfolio. The aspects they really need clarity on is:
- When to buy
- When to sell
- The exact allocation in the portfolio
- The vehicle (bullion bars, gold coins, ETF, gold mining stocks, jewellery)
More China coal investments overseas cancelled than commissioned since 2017
More China-invested overseas coal-fired power capacity was cancelled than commissioned since 2017, research showed on Wednesday, highlighting the obstacles facing the industry as countries work to reduce carbon emissions.
The Centre for Research on Energy and Clean Air (CREA) said that the amount of capacity shelved or cancelled since 2017 was 4.5 times higher than the amount that went into construction over the period.
Coal-fired power is one of the biggest sources of climate-warming carbon dioxide emissions, and the wave of cancellations also reflects rising concerns about the sector’s long-term economic competitiveness.
Since 2016, the top 10 banks involved in global coal financing were all Chinese, and around 12% of all coal plants operating outside of China can be linked to Chinese banks, utilities, equipment manufacturers and construction firms, CREA said.
But although 80 gigawatts of China-backed capacity is still in the pipeline, many of the projects could face further setbacks as public opposition rises and financing becomes more difficult, it added.
China is currently drawing up policies that it says will allow it to bring greenhouse gas emissions to a peak by 2030 and to become carbon-neutral by 2060.
But it was responsible for more than half the world’s coal-fired power generation last year, and it will not start to cut coal consumption until 2026, President Xi Jinping said in April.
Environmental groups have called on China to stop financing coal-fired power entirely and to use the funds to invest in cleaner forms of energy, and there are already signs that it is cutting back on coal investments both at home and abroad.
Following rule changes implemented by the central bank earlier this year, “clean coal” is no longer eligible for green financing.
Industrial and Commercial Bank of China, the world’s biggest bank by assets and a major source of global coal financing, is also drawing up a “road map” to pull out of the sector, its chief economist Zhou Yueqiu said at the end of May.
(Reporting by David Stanway; Editing by Kenneth Maxwell)
Bank of Montreal CEO sees growth in U.S. share of earnings
Bank of Montreal expects its earnings contribution from the U.S. to keep growing, even without any mergers and acquisitions, driven by a much smaller market share than at home and nearly C$1 trillion ($823.38 billion) of assets, Chief Executive Officer Darryl White said on Monday.
“We do think we have plenty of scale,” and the ability to compete with both banks of similar as well as smaller size, White said at a Morgan Stanley conference, adding that the bank’s U.S. market share is between 1% and 5% based on the business line, versus 10% to 35% in Canada. “And we do it off the scale of our global balance sheet of C$950 billion.”
($1 = 1.2145 Canadian dollars)
(Reporting by Nichola Saminather; Editing by Leslie Adler)
GameStop falls 27% on potential share sale
Shares of GameStop Corp lost more than a quarter of their value on Thursday and other so-called meme stocks also declined in a sell-off that hit a broad range of names favored by retail investors.
The video game retailer’s shares closed down 27.16% at $220.39, their biggest one-day percentage loss in 11 weeks. The drop came a day after GameStop said in a quarterly report that it may sell up to 5 million new shares, sparking concerns of potential dilution for existing shareholders.
“The threat of dilution from the five million-share sale is the dagger in the hearts of GameStop shareholders,” said Jake Dollarhide, chief executive officer of Longbow Asset Management. “The meme trade is not working today, so logic for at least one day has returned.”
Soaring rallies in the shares of GameStop and AMC Entertainment Holdings over the past month have helped reinvigorate the meme stock frenzy that began earlier this year and fueled big moves in a fresh crop of names popular with investors on forums such as Reddit’s WallStreetBets.
Many of those names traded lower on Thursday, with shares of Clover Health Investments Corp down 15.2%, burger chain Wendy’s falling 3.1% and prison operator Geo Group Inc, one of the more recently minted meme stocks, down nearly 20% after surging more than 38% on Wednesday. AMC shares were off more than 13%.
Worries that other companies could leverage recent stock price gains by announcing share sales may be rippling out to the broader meme stock universe, said Jack Ablin, chief investment officer at Cresset Capital.
AMC last week took advantage of a 400% surge in its share price since mid-May to announce a pair of stock offerings.
“It appears that other companies, like GameStop, are hoping to follow AMC’s lead by issuing shares and otherwise profit from the meme stocks run-up,” Ablin said. “Investors are taking a dim view of that strategy.”
Wedbush Securities on Thursday raised its price target on GameStop to $50, from $39. GameStop will likely sell all 5 million new shares but that amount only represents a “modest” dilution of 7%, Wedbush analysts wrote.
GameStop on Wednesday reported stronger-than-expected earnings, and named the former head of Amazon.com Inc’s Australian business as its chief executive officer.
GameStop’s shares rallied more than 1,600% in January when a surge of buying forced bearish investors to unwind their bets in a phenomenon known as a short squeeze.
The company on Wednesday said the U.S. Securities and Exchange Commission had requested documents and information related to an investigation into that trading.
In the past two weeks, the so-called “meme stocks” have received $1.27 billion of retail inflows, Vanda Research said on Wednesday, matching their January peak.
(Reporting by Aaron Saldanha and Sagarika Jaisinghani in Bengaluru and Sinead Carew in New York; Additional reporting by Ira Iosebashvili; Editing by Sriraj Kalluvila, Shounak Dasgupta, Jonathan Oatis and Nick Zieminski)
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