Silver and Gold in the Modern Portfolio (w/ Ned Naylor-Leyland)

Silver and Gold in the Modern Portfolio (w/ Ned Naylor-Leyland)


NED NAYLOR-LEYLAND: I’m Ned Leyland. I’m the Portfolio Manager of Merian Global
Investors Gold and Silver Fund. The fund is a combination of bullion, held
in bullion trusts, and gold and silver mining equities. If you’re asking about a forecast for gold
prices, you have to think about it in your base currency. And actually, for a lot of investors, because
they’re not taught about gold– and gold sort of lives under the table– it’s this kind
of strange, esoteric subject– investors, even professional investors, struggle with
this problem. So they, they. So people based in London look at gold in
dollars, which is just completely unhelpful. So my outlook for gold is always a 12-month
and longer time frame because I think that’s the way you need to think about it. And it’s based on gold’s actual positioning,
which is in the cash and bond market. People get very excited about what may or
may not be happening in equities. But, of course, gold is a cash-money instrument. And it behaves inversely to dollar real yields. That’s to say it’s not about inflation on
its own, and it’s not about rates on its own. But it’s about the relationship between the
two. And right now, we have– depending on who
you speak to– three or four hikes, still priced in on a forward-looking basis. And I tend to say that I think it’s more likely
we’re going to get less than we are going to get more than that. But, you know, I look at the Barclays-Bloomberg
7- to 10-year Real Yield index as a key forward-looking measure of what’s happening in cash, or rather–
let me rephrase that– what the bond market thinks is happening in cash. But I think therein lies the investment case
for gold, really, which is, there’s a huge difference between what the bond market is
pricing and what participants actually believe. And I think that that’s the way to think about
gold. So to dig into that slightly, if you look
at that index, it’s suggesting that a dollar will be worth between 100 cents and 101 cents
seven to ten years in the future. But when I anecdotally poll investors and
potential investors in my fund about what they think the purchasing power of $1 will
be on that forward-looking — basis seven to 10 years– they will, to my surprise, but
delight, too, actually come up with an average number of $0.50. So investors seem quite clear that the dollar,
and sterling, and anything else is losing purchasing power a lot faster than the screen
suggests. But yet, when it comes to actually investing
in what the bond market itself says on the screen, it’s still at 101. So my thesis for gold here, in terms of dollar
pricing, is that there is a big, big problem here between $1.01 and $.50. Now, at what speed are we going to see that
$1.01 head to $0.50. It’s not, in my view, not going to go the
other way. I’m not sure. But at the moment, we’re still several hikes
priced in, and a very rosy perspective as to what central banks can do in an environment
where, clearly, we’ve had an incredible unleashing of credit through the system consistently
for 20 years. I think gold is in a very good place to rally
considerably, once the bond market– the cash-market– peoples who are holding these instruments–
start to become nervous about their loss of purchasing power. I think there’s a flaw because they’ve been
forced in an environment where, really, things have been very, very loose for a very long
time. They’ve been forced to hold the bull markets
head up by promising things that they can or can’t deliver. So far, they have delivered. They delivered it on a very delayed basis,
by the way, because there was about four years where they talked about rate hikes and didn’t
do anything. But the bull market was a good, compliant
puppy, and did what it was told back then, before anything was delivered. So I think the floor is more just a relationship
between the bond market and the central bank. It can’t be any more compliant than it already
is. I suppose that’s the way I see it. You know, at some point, the bond market is
likely to say– even if it should gently– I’m not sure that we can continue to do these
hikes or these hikes are actually beneficial– that there might not be some big macro problem
created by doing it. So I think that that’s really where the flaw
comes from. It’s this relationship between the central
bank and bull market. It’s so tight that I don’t really see how
it can force real yields any higher than is already priced in. I’m very interested in silver. And silver’s a big part of our portfolio. But silver really is just the highbeat version
of gold. I mean, its not, people get very confused
by silver because it has enormous industrial utility– in fact, so much so that it can’t
be replaced in many, many items. But it does still behave as the partner of
gold, and it trades on an inverse relationship with real yields. So look, my thing about silver is I think
in portfolio-construction terms, it’s very sensible to utilize that beater within the
portfolio because it actually ends up meaning I can buy larger, larger stocks than I would
otherwise need to buy to get that return profile in my portfolio. But the truth is of silver– at some point,
is likely to decouple, I think, because I think that the just-in-time delivery system
of the bullion-banking world for silver might start to become a problem for industrial uses. They might become nervous, and they might
seek to grab whatever physical imagery they can get hold of. And at some point, I think that will decouple. But for now, it’s just a pure way of accessing
return profile in the funds. And I think if you’re going to invest in gold,
you should always think about silver alongside it. We combine bullion– gold and silver– with
mining equities. One of the reasons for that is I think that
gold and silver stocks can be quite liquid. In fact, they can be very liquid, depending
on market conditions. And I think that investors are interested
in both bullion and mining equities. Mining equities are a real investment. Gold and silver mining equities are an active
investment, whereas for me, physical gold and silver is money. It’s not an investment. What it is sound money that doesn’t degrade,
is very important, and it provides like a cash buffer within my portfolio. But I think that the mining equities are the
active investment in the space. Now, having said that, they’ve been horrible
for a long time. There have been very short periods they’ve
done very well. But really, they are suffering from a very,
very big and very important structural problem, due with the misreporting of inflation. And I think it’s a very profound observation
that inflation is much higher, in real terms, than the statistics infer. There’s plenty of evidence for this if one
bothers to dig into it. And I think that if you think about a gold-and-silver
mining company as selling something, which is priced of inflation on the screen– because
of course, gold and silver price of real interest rates, and when interest rates take into account
the formal data on inflation– so they’re selling something which is pegged to Bloomberg,
as it were, whereas their costs are not. Their costs are real. Their costs are rising in a much more secular,
structural way, based on the real inflation rate in the real economy. That creates a horrible-investment case for
gold and silver equities, which is probably not what I should say, seeing as I invest
in them. But that’s also where the opportunity lies
to me because, you know, we’ve had 20-plus years of this problem being in place in the
sector. And I think that what’s happened is we’ve
ended up with now a really profound operational gearing built into the stocks. So long as you buy quality, you don’t go chasing
racy ones– there’s an enormous amount of operational gearing to rising gold and silver
prices available in there. And for me, I don’t think physical gold and
silver on its own is enough of a hedge against the issues of the structural issues of the
monetary system because if you, you know, have a 2%, 3%, 5% position in physical gold,
what you’re doing is you’re saying, I want a 2% 3%, 5% vote no in my capital. Well, that’s fine, but that’s not going to
make up for potential very large write-downs elsewhere in your net-worth pie chart, and
wants to explain it like that. So for me, the gold and silver mining equities
are a bit like an untimed call option. Now, you want someone to manage it for you
because I think it’s a very technical industry. It’s not somewhere you should just be picking
an individual gold stock– go ahead and go with that one. I think the idiosyncratic risk of individual
mining companies is much greater than people realize. The skew is not in your favor buying individual
names. So whether one wants to buy an index or a
managed fund, the likes of which I manage, I don’t really think that that’s something
I’m going to push someone towards– but I do think holding individual names is a bad
idea. But I also think that this is the finest way
to have a really meaningful and geared exposure to a major-trend reversal, which I think everybody
is worried about. Lots of people are worried about this, quite
rightly, because there’s so much herding, so much concentration, so much correlation,
inability for people to own things which are going to move fast the other way. And for me, this is what gold-and-silver mining
stocks represent. Now they need to be selected carefully. We don’t buy companies that are based in Africa,
Central Asia, Russia– anything like that because I don’t think you need the additional
risks involved in that to capture the return profile. But I do think that, you know, some people
believe they can hedge themselves by holding derivatives, holding, basically, a timed short-view
on things. For me, that’s not the best way to do this
because I think the big problem people have is timing this structural issue that we’re
all talking about. And gold-and-silver mining equities– so long
as they don’t go bust in the meantime– are a very good way of achieving that. The individual gold-and-silver mining stocks
are a real problem for most investors. The temptation is to, is to buy them. But you need the knowledge– not actually
even of a geologist, but specifically, of a mine engineer– in order to be able to integrate
the financials and the operating side of mining companies, particularly underground gold-and-silver
mining companies. They’re very, very technically complicated. So I think that if you don’t have that, it’s
a fool’s errand in buying individual stocks because what you’re doing is you’re saying,
oh, I know better than my engineer. I mean, you’re not explicitly saying that. But you’re inferring this because an index
or a fund is going to capture 90%– 80%, 90% of any upside in an individual name. But what you’re doing by investing in an index
or a fund is you’re avoiding the huge downside risk that can be caused by, well, whether
it’s geopolitical, whether it’s operational– whatever specific idiosyncratic risk there
is– there are many, many of them– and they usually do come along when you not expecting
it. So I feel strongly that avoiding that problem
by layering your exposure is more pertinent in this sector than anywhere else. This idea that gold-and-silver mining companies
are brilliant at capital instruction, I think, is just wrong. And it comes from a lack of understanding
of this problem of costs versus the gold price. So just to go into that a little bit, gold
is money, silver is money. And they’re pricing of full stature in the
bond market. And I’ll say, for me, that, that it’s not
just the work John Williams of Shadowstats. There are other things as well, which indicate
that inflation can be around probably average 9% over the last 20 years. I know that sounds completely shocking. But by the way, in truth, , you know, a lot
of the most-interesting investors I meet would agree with me. They want to be up 10% net per year. Otherwise, they feel they’re down. So that actually confirms that point. But if you accept that, then there’s a huge
input-cost problem for these companies. And we see it consistently when you model
them out proper. You can see it’s there. And they’re not able to hedge that away or
avoid that problem. If costs are rising at 10, and gold is up
1, it’s not a management problem. Now, don’t get me wrong. There are issues with corporate governance,
renumeration. But I don’t think there are any bigger than
they are elsewhere in other sectors. I think that there’s a narrative here which
doesn’t really bear out when you really dig into it. The issue is with the way inflation is reported,
and thereby, the way real-interest rates price gold. And that’s where both the problem has come
for a very long time, but also, where the enormousinvestment opportunity lies because
if gold does start to break out in a major way, you’re going to see massive margin expansion,
operational gearing to the upside for these companies. And people can make fantastic returns on that
basis. Yeah, the central banks have managed to prolong
the cycle hugely, in my view. And I think that they’ve done that by making
the bond market compliant. Or the bond market has willingly been compliant
in that. Now what do I do to avoid this problem? Well, stock selection is the obvious one,
which is, you don’t just pile into the most balance sheet distressed and highly operationally-geared
names. You want a good selection of high-quality
gold-and-silver mining companies. They do exist, despite what people say. So I think that there’s, there’s an obvious
stock-selection point. But I think that the more interesting question,
really, is for the investor and how they allocate towards me, or sector, rather than the other
way around. And that, for me, is just a position-sizing
point, which is, there is a tendency that once you understand the monetary system, or
you feel you understand the problems of the monetary system well, to get particularly
fearful or greedy in taking too much of an overweight view. So if we talk about the prolonging of the
cycle, you know, I think it’s, for me as an investor for myself, rather than necessarily
in the fund, what I would say is, I think, it’s about, what position do I want directionally
hedging this problem? And what is that particular allocation going
to do for me in that environment? Now that might seem like a really obvious
point. But I don’t think that people handle that
well. So I think that being in markets, in momentum,
in this strange world– twilight-zone financial markets that we’re in– is, is a compelling
and necessary thing to do. But I do think that having an allocation,
a 2% to 5% allocation, for example, in a fund like the one I run is a good number. Now, am I at 2% to 5% myself? No. So am I being a hypocrite saying that? Yes. I do take a much bigger view, but then I’m
happy to bear the volatility of that. And that’s the point. So people say to me, oh, gold’s volatile. Silver is really volatile, and gold and silver
stocks are crazy volatile. Now, I’ve been investing in them long enough
to be quite sort of immune to that. I don’t really feel it, I think, the way other
people do. But that’s just about position sizing. So if you can’t handle the volatility, then
you need to down-weight your position. And that doesn’t mean you don’t have it. It just means you understand what the right
quantum is for you. And I think that a good proportion of people’s
negative perspective on this asset class is because they’ve understood the structural
problem, then they’ve got their position-sizing wrong. And actually, you know, if gold and silver
stocks are down 15% over eight months, and people are moaning, you know, it’s probably
a good sign that things aren’t doing that badly. And it is an overall view. And we have to think about it that way. Balance at the moment, the portfolio’s 20%
bullion and a slightly underweight position in silver miners versus gold miners. But that’s purely because silver has underperformed
gold for, gosh, nearly two years now. So there’s been a negative drift there. And I’m not constantly fighting it by just
buying blindly. But broadly, the positioning remains the same. I mean, if the sector really starts to signal
very bearish, for me then I would go higher in bullion. And I would sell some of the operating-mining
companies and royalty in streaming companies because generally, they do quite well in a
difficult environment for dollar-gold prices, mainly because they get to buy more streams
and royalties from distressed-operating companies. But for now, I’m still in position– about
20% in physical, and the rest in the, in the miners. The sector does badly from here if we get
even more tightening that’s priced in. Now, you know, I don’t buy that narrative? Some people do. And it could happen. But I think there’s so much bad news priced
in. And there are actually some really good-news
stories. One of the particularly good-news stories
for me, in the gold-and-silver mining equities is the really quite-exciting change in the
way mining is happening– so for example, the introduction of tech. Now don’t get me wrong. Gold-and-silver mining companies are about
the last people to change what they do, but it is happening. We’ve seen lots of small, incremental changes
to mining processes, whether it’s the use of drones in surveying of open pits, whether
it’s driverless, automated haulage, whether it’s improvements in milling, grinding. There are lots and lots of small changes. I think all of these are going to drive big
operation improvements over the next two to five years. Now, I will admit, this is at the margin. But I think it’s very interesting, and I think
it’s a big change for the industry. So I think that that’s something very positive
to look forward to. But overall, we’re in an environment now where
real yields are where they are. We should see a shift back to the norm– a
closing of the gap between $1.01 and $0.50. I don’t know what can be a catalyst to do
this. There are many things that are lurking, I
think, which can drive people away from this narrative of tightening of central-bank balance
sheets. I’m not sure what’s going to do it, but I
think something is coming at some point over the next 12 months, which will make people
question the ability of central banks to continue to do that. So 2008 often gets referred to. But we’re not there anymore. And it’s not a it’s-different-this-time point. It’s very, very clear what happened to me. If you look at the Real Yield index I referred
to, what you will see is before QE was mentioned, we were in a deflationary collapse. That meant that money on deposit, dollars
on deposit, on a forward-looking basis were, according to the bond market, gathering purchasing
power just being sat there. Now that is not good for the dollar-gold price. So the dollar-gold price went down nearly
30% in very short order during 2008 before this new, wonderful world of QE was even discussed
openly. The moment that happened, it turned. The bond market understood that we are now
in an environment where conventional-monetary policy is not around. And we are still in that post-’08 environment,
where if we need to, we can go into yet more unconventional environments– more QE, negative
rates– all these things. We’re not where we were in ’08 when gold went
down 30%. It went down 30% because the bond market–
if you look at the Barclay’s-Bloomberg index, it was pricing $1.04. So it was saying, money will be worth 4% more
in seven to 10 years’ time than it is today. I cannot see any environment of stress where
the bond market is going to be pricing that. For me, it’s clearly going to go the other
way. And people will realize we’re going from what
is already a tight environment to an extreme-loose one very quickly. It should be the opposite of what we had before. Central banks are very interesting. People talk about their inability to forecast. But I’m not sure that that’s really what goes
on. I think that, as JP Morgan, said, “gold is
money, and everything else is credit,” and central banks understand that very well. I also think, by the way, these commercial
banks and commercial-bank economists don’t understand it at all. Indeed, I had a conversation with a very high-level
economist from a big bank recently. And he described what was going on in Asia,
respect to de-dollarization, it’s just complete nonsense, it’s not happening, it’s just not
interesting. And I brought up gold, and he described it
as shiny Bitcoin. And I said to him, but your own central bank
has 2/3 of its reserves in shiny Bitcoin. And there was a look of amazement when I made
that point. Now, I think central banks are the signal,
you know. They hold, really– leaving aside the equity
component that central banks have added– some have- – let’s just leave that aside for
a moment. Central banks hold two things. One is money, and the other is credit. Or at least, that’s my perspective on it. Now, they’re seeking to add this, and they
don’t want to add any more of that. That tells you we’re at a very-important moment,
cyclically. It’s a difficult thing to pitch because that
doesn’t show up in pricing because, of course, gold– and so then people say to me, oh, yeah,
but then why doesn’t go go up? Why is it not going up? Well, the answer is, the physical market is
tiny. But the central banks only participate in
the physical market. Now, that’s not true what I just said. They only participate as a buyer in the physical
market, the tiny physical market. They do participate actively in the paper
market, learning, leasing, swapping reserves. But when they want to add, they buy physical. So there’s a strange world we live in, where
they’re buying. They’re adding physical reserves and repatriating,
of course, which is an important point– wanting their own gold reserves at home, rather than
with other nations. I think this is a huge secular thing. I don’t think it’s anything anybody should
be ignoring. Can the average investor get out to the Bundesbanks? 67% of reserves in gold– probably not. Do I think that that’s something that’s flashing
at investors that people ignore? Absolutely. I was in Germany a year ago. I asked German investors what, what they thought
the Bundesbank’s gold holding was. None of them had any idea. They didn’t know what that– and they were
surprised they didn’t know as well. And when I pointed out that that was the case,
they were absolutely amazed. And I think that it’s just that simple. Central banks understand, that’s money, that’s
credit. And they need to balance the two out. Now unfortunately, that means some central
banks don’t have enough money, and they have too much credit. And I think it’s very difficult for those
ones to do anything about it because if they do, it starts to look a little bit dodgy for
them. If they start trying to rush away, then, you
know, it’s ringing a bell. So I think at the margin, this is the most
important thing and the thing that most qualifies why this asset class and a position in this
asset class, even if it it’s going down while everything else is going up, is there for
a reason. And not owning gold and not having exposure
to gold, or silver, or the mining equities; for me, is a much bigger risk than a correctly
sized position and the fact that it may go down a bit while markets continue to go up. And I suppose that’s the point, really. What’s the bigger risk– having some in your
portfolio or not having any? And for me, it’s very clear. It’s definitely not having any at all. In a world where we were awash with credit,
and everything is somebody else’s obligation, the one thing that isn’t is something that
really ought to be in everybody’s portfolios. Sequencing for a blue-sky scenario for gold,
I think is, not how I see it, really. And the reason why I say that is because I
do think that gold is the denominator. So all I see, really, is that we’re in a situation
where we’re in the final 1% of purchasing power of the existing monetary system. And it’s being degraded very, very fast, despite
what central banks may tell you. Now, I think that if you hold a position in
physical gold, there can be a big rerating, versus your, your base currency. And it can look very good, and you can do
very well. And that will be all about the move from $1.01
in the bond market to $0.50 in reality. So at what point people start to realize that
they are shipping purchasing power holding cash– that’s the key driver of everything. I don’t know when it happened in the 1970s,
it was actually an oil spike and made people realize something that was already there. It was already there. But people, with a big rise in oil, suddenly
feared inflation in real terms, and they behaved in a certain way. But for me, still, it’s all about the mining
companies because that’s where the real return comes. If you really want to make a big return here,
be one of those people who makes a lot of money in a systemic shift, it’s going to be
in the mining companies, not in physical, because physical is money. What it’s going to do is what it’s always
done, which is hold your purchasing power against goods and services. There can be one- two-year uplifts and downdrafts. But generally, that’s what it does. That’s what it’s for is money. But the mining equities are not bad. And if you are participating at the right
time, when people start to flee cash and bonds, and it’s not about equities– now, by the
way, of course, equities going down can, of course, be the trigger that makes the bond
market realize we’re not getting all these rate hikes. And that can create real yields going down. But it’s always through the bond markets. It’s about cash and bonds. When do people stop wanting to hold those? I think it’s already there, by the way. I think we’re seeing what was a very small
trickle is it a little bit more than that. At the moment that turns into more than that
and turns into a river will be the moment when we get phase change. And gold and silver mining stocks can really
start to go at that point. Physical will do well, and people will be
very happy they own it. But the opportunity set for me is in the stocks,
not in the bullion.

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