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What's driving the bull market in bullion

Dynamic fund manager Robert Cohen focuses on small- and mid-cap gold producers.

Michael Ryval 28 July, 2016 | 5:00PM
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A confluence of factors has driven gold bullion in the past year to US$1,330 an ounce, from US$1,100, in the process also giving a healthy boost to gold stocks. And while Robert Cohen, a long-time gold specialist and vice-president at Toronto-based 1832 Asset Management LP, is reluctant to give a precise price target where gold might be in another year's time, he maintains that conditions are in place to push the shiny metal ever higher.

"We've had a combination of factors supporting gold, from fear of currencies devaluing, to a massive expansion of global liquidity and central-bank easing and negative real interest rates in many countries," says Cohen, who oversees Dynamic Precious Metals and Dynamic Strategic Gold Class.

In the 12 months ended July 15, the former fund returned 117.9%, versus 32% for the S&P/TSX Global Gold Total Return Index. The latter fund, which holds about 30% bullion in its portfolio, rose 65.6% in the same period. Cohen has managed Dynamic Precious Metals since January 2000, and the bullion-oriented Dynamic Strategic Gold since its inception in August 2009.

Another key factor behind the run-up in the gold price is that investors who sold 900 tons of gold held in exchange-traded funds in 2013, a year which saw the U.S. dollar soar against many currencies, have rushed back in again.

That move has been prompted in part by negative real yields for sovereign bonds, in jurisdictions such as Germany, Switzerland and Japan, which makes the cost of owning gold more attractive. Even the U.S. has seen the yield for benchmark 10-year Treasury bonds drop to about 1.5%, a shade above inflation in that country.

"There's been an equal and opposite reaction to what happened in 2013. It's a 180-degree switch in thinking," says Cohen, a mining and mineral-process engineer by training who joined 1832's predecessor firm, Goodman & Co. Investment Counsel Ltd., in 1998. "In the meantime we have Europe on the rocks because of the Brexit referendum. And Europeans and Americans are stepping in to protect the purchasing power of their currencies."

Another key barometer is the gold-silver bullion ratio, which is holding steady. With silver at US$20 an ounce, the ratio is about 66.25. "It's been in the high seventies, and last year was probably 75. So it's moving down. But it's still on the other side of the mean," says Cohen, adding that the mean has been 55 over the last 35 years.

In his stock picks, Cohen has focused on mid-cap and junior mining companies, and shunned giants such as  Barrick Gold Corp. (ABX), which lack the growth dynamics of more nimble players. The significant run-up of some stocks has meant that Cohen has had to boost the bullion weighting in Dynamic Strategic Gold Class to keep it around 30%.

"Equities were moving faster than the bullion price and changed the proportion in gold. If I let it ride, it would be closer to 20%," says Cohen, adding that the fund holds mostly senior and intermediate producers and fewer exploration firms than Dynamic Precious Metals.

One representative holding in both funds is Detour Gold Corp. (DGC), which has emerged as a so-called "10-bagger." Detour operates an open-pit mine in northern Ontario and produces about 580,000 ounces a year. "In the early years, with the lower gold price people were worried they would run into trouble," says Cohen. "They did have a few hiccups at the start but have worked their way through it. They have also renegotiated the terms on their debt and lease payments."

Shares in Detour Gold have soared from under $3 in November 2013 to around $31.50. "When things are negative in the gold market," says Cohen, "they assume some good companies are not going to make it." During the gold-price slump in 2013, "people thought this was game over." But Detour has the advantage of owning a mine that is capable of becoming very profitable. "This was a case where you had a quality company and a good mine."

Another favourite name held in both funds is Semafo Inc. (SMF), which produces about 225,000 ounces of gold in Burkina Faso in West Africa. Production is expected to rise to 400,000 ounces by 2019 as new mines come on stream. Since late 2013, the share price has risen almost 300%.

Semafo is undervalued relative to its peers, says Cohen. He noted that the stock was trading at 94% of its net asset value, versus the peer group which trades at a multiple of 120%. "A reasonable target would be a 10% to 20% premium to net asset value. There is still some meat left on the bone." In 2007, Cohen adds, the price-to-net-asset-value multiple for the peer group got as high as 180%.

Will history repeat itself? "When things change, they can change very quickly," replies Cohen. "Don't try to time the market. You should own gold at all times, in the event of any volatility. Gold is the most uncorrelated asset class."

Cohen notes that the gold price rose appreciably in the first quarter of 2009, as central banks averted the global financial crisis. "Right now, because of the combination of expanding global liquidity and Brexit, and so on, you will see an infusion of capital. It's not a bad thing for broader markets. And it's also a good thing for gold."

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Michael Ryval

Michael Ryval  Michael Ryval, a regular contributor to Morningstar, is a Toronto-based freelance writer who specializes in business and investing.

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