+ About Peter Hall
Peter Hall is the Chief Executive Officer and the Managing Director of Hunter Hall International Limited, a publicly listed entity. He is Chief Investment Officer of Hunter Hall Investment Management Limited and Executive Chairman and Executive Director of Hunter Hall International (UK) Limited. He is a Trustee of the Charitable Trust Hunter Hall International Limited. Peter has 32 years of experience in investment markets.
Peter is also a Patron of the Asian Rhino Project and Sea Shepherd UK, a Director of the International Rhino Foundation and a member of the Sydney Film Festival Council.
Prior to Hunter Hall he was the Investment Manager of Hancock & Gore Limited, Portfolio Manager and Analyst with Mercantile Mutual Holdings Limited, Industrial Analyst with Pembroke Securities Limited, Investment Analyst with New Zealand South British Insurance Limited and a journalist with John Fairfax & Sons Limited.
Peter completed the Harvard Business School Owner/President Management Program in 2003 and a Bachelor of Arts Degree from the University of Sydney in 1991. He was awarded Member (AM) of the Order of Australia in 2010 for his philanthropic contributions to society and his service to the finance management industry.
Thursday, July 28, 2016
By Peter Hall
I started my journey investing in gold in 2014, observing that a stock I sold out of our funds in 2012 – at average prices of over $2 per share – had fallen to below 10c. That stock was St Barbara Limited (SBM).
As I researched St Barbara, I discovered that the gold sector was profoundly out of favour. There were a number of stocks selling at low valuations compared to their likely cash flows at the current gold prices.
We did not invest with the expectation that the gold price would rise. Rather, it was on the premise that it would stay flat, or go down. We purchased two stocks – St Barbara and Doray Minerals (DRM) – which shared the characteristics of the highest production grades and margins so they would still be profitable even if the gold price fell.
Why gold should rise
I recognised the potential for the gold price to rise, at some unknowable time in the future, for two reasons.
Firstly, the amount of gold in the world is growing at a very slow rate, particularly when compared to the rate of growth of paper money given fiscal deficits, quantitative easing and the growth of derivatives. Put simply, if the volume of paper money is growing quickly and the volume of gold (a form of money) is rising slowly, then the price of gold – expressed in paper money – will inevitably rise.
Secondly, people want to hold more gold in an increasingly risky and incomprehensible world. The world is divided into four large economic and political blocs including China, Japan, Europe and the United States. Of course, there are many other players, but the balance of the world lies in the relationships between these four. For the last few decades, they have lived in an uneasy and fragile truce, where the relativities of interest rates, currencies and trade and capital flows have been acceptable to all.
I used the word ‘fragile’ to indicate that the global balance is not guaranteed and is vulnerable to shocks. One such shock has just occurred in the form of Brexit, which is likely to lead to significant changes to the European Union and the Euro. One possible scenario is the collapse of the Euro and/or the European banking system. This could be followed by a crisis of national finances as sovereign debt increases rapidly, possibly exacerbated by a recession which would reduce tax revenues and increase government spending. The only way out would be further creation of paper money and further degradation of its quality.
The interest rate game
Interest rates have declined to very low levels and many government bonds now have negative real interest rates. This threatens the balance of interest rates and currencies between the Big Four. Whenever the US hikes rates, the Chinese devalue their currency and that means their goods become cheaper. This greatly impacts the industrial activity of Japan, Europe and the United States.
China – the workshop of the world
Over the last 40 years, China has become the workshop of the world through innovation, human enterprise and central government assistance.
The graph shows the share of world trade of China and Japan. In the late 80’s, Japan had a 10% share of world exports. This has fallen to about 2.5%. China, on the other hand, has risen to 12.5%, winning share from Japan, Europe and the United States. Wealth is being transferred to China from the other three and is destabilising their relationships at many levels.
Japan and China’s Share of World Exports (%)
Source: Grants Interest Rate Observer Conference, April 2016. Scott Bessent, Keysquare
The bar bell portfolio structure
As a value manager with a flexible investment mandate, we can invest anywhere in the world. That generally leads us to investing in small to mid-cap stocks. The stocks that have driven most of the performance have been those with a risk and reward ratio that’s tilted towards reward. These stocks have a payoff profile by having operating or financial leverage. They may have a lot of debt, and if sales go up or down, there is a big impact on profit or loss.
The Hunter Hall Value Growth Trust (VGT) and Hunter Hall Global Value Limited (HHV) portfolios have a ‘bar bell’ structure. Part of the portfolio is in the game of making returns and another part is risk averse. Almost a quarter of the portfolio is in cash (20-25%), 20% is in gold companies and the remaining 55%-60% is invested in other equities.
The gold rationale
I think gold has a wonderful future because the ratio of paper money to physical gold is in gold’s favour. As mentioned previously, more and more paper money is being generated as governments overspend and keep interest rates low.
This chart shows how gold discoveries have fallen over time, production remains weak, and the price of gold has been rising.
Gold Discoveries – Fallen Since 1980s
Source: Grants Interest Rate Observer Conference, April 2016, Pierre Lassonde, Franco Nevada Corp.
You would think that as the price of something goes up, production would increase, but this has not been the case for gold. Mines are going deeper, which costs miners more money. Gold is so rare that it is economically viable to mine ore with one part gold per one million part rock (or 1 gram per tonne). There is only a finite supply of gold and there haven’t been any significant technological innovations in gold production since the 1980s when heap leaching was developed. The bottom line is that the rate of gold discoveries has fallen and production is growing very slowly, even while the gold price has increased considerably.
The demand for gold
Gold demand is rising. In 1980, demand for physical gold was about 1,800 tonnes a year. It is now over 4,000 tonnes a year, rising around 3% per year since 1980.
Gold demand up about 3% a year since 1980
Source: Grants Interest Rate Observer Conference, April 2016, Pierre Lassonde, Franco Nevada Corp
Part of the reason for the recent spike in the gold price has to do with interest rates. When you have negative interest rates (which we have in a large part of the world’s bond markets) why not put your money into gold, rather than a currency that gives you a negative return?
Our initial portfolio of two high-margin gold producing stocks (which make up 75-80% of our gold portfolios) has been added to with some speculative plays. These make up 20%-25% of our gold portfolios. Beadell Resources (BDR) owns the third largest mineral mine in Brazil and has substantial exploration potential. Two other names we hold are Blackham Resources (BLK) and Aphrodite Gold (AQQ).
Australian domiciled St Barbara has been a strong performer. At the time of writing, we have turned $8m into $221m. St Barbara is one of the lowest cost gold miners in Australia. It has large reserves, was financially and operationally leveraged when we acquired our stake, and has very impressive management that did a brilliant job turning it around. The long term development of the company will be to further pay down debt and deploy the free cash. Looking at the valuation numbers, my calculus of the current price is about 4 times their cash flow in 2018, so there is definitely room for the stock price to move up.