The case for blending gold with gold mining equities – Expert Investment Views: Invesco Blog

Gold and precious metals mining
equities—as represented by the Philadelphia Gold & Silver Index or XAU—have
suffered in the market downdraft along with other risk assets (down 20.3% year
to date through March 17) after rising an impressive 52.9% in 2019.  They have outperformed the S&P 500 marginally
so far this year and meaningfully over the past 12 months.  Changes in the macroeconomic and geopolitical
risk environments have made both bullion and precious metals mining securities
more attractive in the eyes of many investors. 
Those seeking a non-correlated asset class that may provide
differentiated return characteristics in volatile markets might want to
consider blending their positions in gold with precious metals mining equities
as a part of their overall portfolios.  

A more challenged macroeconomic environment
and increased Coronavirus risk create a tailwind for gold and the gold miners. 
A convergence of factors is pushing
physical gold higher, which is generally good for the precious metals mining
stocks.  Gold is a hard asset that tends to
perform well in a slower growth environment when equity markets are facing
higher volatility, geopolitical turmoil is brewing, real interest rates are
stable or falling, and/or investors fear weakening currencies.  Many of these factors have been manifesting
themselves concurrently in early 2020.  In
addition, fears of a coronavirus epidemic have spooked investors, which has helped
push the CBOE Volatility Index up over 500% in four weeks.  Gold tends to benefit during volatility
spikes as investors seek safe havens.  At
the same time, several other factors that tend to impact gold favorably remain
in place, including easing monetary policies, fiscal stimulus, low to negative
rates and lackluster economic growth. 
This combination of factors helps to explain why the gold price is up slightly
year-to-date through March 17 (after climbing 18.3% in 2019) while many other
asset classes have been hit hard. 

With respect to gold and precious
metals equities, the primary driver of their strong performance over the last
year has been the rising price of gold and other precious metals.  Because the mining equities have both
earnings and operating leverage to metals pricing, the gold and precious metals
equities have historically outperformed the price of gold by twofold to threefold
when both bullion and precious metals mining stocks are rising.  While that has not been the case year to date
as investors have shed risk, it certainly has been true since gold made its
decade low at $1,051 per ounce on 12/17/15, and it was also true in 2019 when the
XAU Index outperformed gold by more than 2.8x. 
(See Figure 1). 

But
there are other reasons for the solid performance of miners as well.  The health of the precious metals sector is
significantly better than during the last cycle—balance sheets are stronger,
miners are generating cash and management teams are staying more disciplined in
terms of both capital expenditures and acquisitions.  Regarding the latter, managements are pursuing
sensible deals at fair prices using rigorous return metrics.  As a result, shares of acquiring companies
are often trading higher upon the announcement of new deals.  Moreover, in the currently low production-cost
inflation environment, efficient operators can capture significant margin
expansion from even modest increases in the price of metals they produce.  In other words, higher quality operators have
significant leverage to rising metals prices, and have benefitted greatly over
the last five years as the price of gold has risen by more than $500 per ounce
while major input costs have declined (e.g., oil, diesel, steel, copper, etc.) 

To be clear—we do not know whether the
next $100 move in gold will be up or down—short term moves in precious metals
are notoriously difficult to predict on a consistent basis.  In addition, leverage
can work both ways; when precious metals prices fall, the mining equities may
decline by even more.  We also recognize
that ETF holdings of bullion and speculative positions in gold are relatively
high on a historical basis.  What we do know
is that multiple factors have come together this year to support gold and even
push it higher.  We also know these
factors are complex, varied and geographically dispersed—and what is good for
gold is often very good for the gold mining equities. 

Figure 1: Performance of Gold Mining Equities vs. Gold
December 18, 2015 to January 31, 2020

What
about combining gold with the gold miners? 
There are several reasons why investors might consider blending
positions in both gold and gold mining equities.  For investors with a constructive view on
precious metals prices, gold and precious metals equities have tended to
outpace the upside performance of bullion due to corporate operating leverage
and amplified earnings.  Simply put, the
defensive characteristics of gold blend well with the upside optionality of the
gold equities.  In addition, while both
gold and the precious metals mining equities have low correlations to
traditional stocks and bonds, mining equities have even lower correlations to
bonds than gold bullion itself, potentially making them attractive to investors
seeking overall portfolio diversification. 
Furthermore, precious metals equities offer investors access to
dividends, mineral diversification and the opportunity to benefit from
corporate actions, none of which is available by investing in physical gold.

Making
room in a portfolio.  Gold
and precious metals equities can be effective portfolio diversifiers and have
the potential to deliver attractive total returns, but they are volatile, and
sector timing is difficult. 
Consequently, we favor a longer-term strategic allocation over a
shorter-term tactical one.  Investors need patience to capture the total
return potential of this asset class, and they need appropriately sized
positions so that they can look beyond the day-to-day volatility of commodity
prices and the price movement of precious metals mining stocks.  For investors who allocate 10%-20% of their
portfolio to alternatives as they pursue diversification and non-correlated
return streams, we believe a position in gold and precious metals equities
should represent a component of that allocation. 

Investors seeking information about Invesco Oppenheimer Gold & Special
Minerals Fund can find additional information here.

Footnotes

All data sourced from Bloomberg L.P.
as of 3/17/20

1.
The XAU Index has a correlation of 0.12 to the S&P 500 and 0.25 to the
Bloomberg Barclays U.S. Aggregate Bond Index for the 10-year period ending
1/31/20.  The S&P GSCI Gold spot
price has a correlation of 0.02 to the S&P 500 and 0.40 to the Bloomberg
Barclays U.S. Aggregate Bond Index over the same period.  Source: Morningstar, 2/27/20.

Important
Information

US
equities are represented by the S&P 500 Index. An investment cannot be made
directly into an index.

The
Philadelphia Gold & Silver Index is an index of 30 precious metals mining companies
that are traded on the Philadelphia Stock Exchange. Index performance includes
total returns. The index is unmanaged, includes the reinvestment of dividends
and cannot be purchased directly by investors. Index performance is shown for
illustrative purposes only and does not predict or depict the performance of
any fund. Past performance does not guarantee future results.

The
mention of specific companies, industries, sectors or issuers does not
constitute a recommendation by Invesco Distributors, Inc. Certain Invesco funds
may hold the securities of the companies mentioned. A list of the top 10
holdings of each fund can be found by visiting invesco.com.

The
opinions expressed are based on current market conditions and are subject to
change without notice. These opinions may differ from those of other Invesco
investment professionals.

Fluctuations in the price of gold and precious metals may affect the profitability of companies in the gold and precious metals sector. Changes in the political or economic conditions of countries where companies in the gold and precious metals sector are located may have a direct effect on the price of gold and precious metals.

Commodities
may subject an investor to greater volatility than traditional securities such
as stocks and bonds and can fluctuate significantly based on weather,
political, tax, and other regulatory and market developments.

To the
extent the fund invests a greater amount in any one sector or industry, there
is increased risk to the fund if conditions adversely affect that sector or
industry.Before
investing, investors should carefully read the prospectus and/or summary
prospectus and carefully consider the investment objectives, risks, charges and
expenses. For this and more complete information about the fund(s), investors
should ask their advisors for a prospectus/summary prospectus or visit
invesco.com.