[Editor’s note: For Part 1 of this article, please click here]
It was Warren Buffett who said that you learn who’s been swimming naked when the tide goes out. But it is Tyler Mordy who’s pointing out the few swimsuit-clad investment products standing on the shore now that the tide of economic growth has clearly ebbed—and some of them have a golden glow. A widely recognized innovator in the design and application of actively managed Exchange Traded Fund portfolios, Tyler is Research Director for HAHN Investment Stewards and publishes its ETFocus every other month. In this exclusive interview, he tells The Gold Report readers that global multi-asset ETF portfolios having investments in gold and gold stocks present excellent opportunities not only for preserving but building wealth. Case in point: inflows of 105 tons into gold-backed ETFs in January—approximately half the world’s gold mine output for the month—pushed ETF bullion holdings to a record 1,317 tons.
TGR: What plays would you put on the Asian emerging markets?
TM: Our thesis has been that Western markets have been in a secular bear market since 2000. In the hard bloc world, it’s the opposite. We are emphasizing Asia—India and China in particular. We have seen some indiscriminate liquidation in those markets due to what David Fuller (Fullermoney Global Strategy Service) calls the Wall Street leash effect—or Wall Street-led contagion. S&P figures for January show emerging Asia trading on 8.4 trailing 12-month P/Es, whereas the United States is trading on 17.5. The dividend yields in emerging Asia are about 5% on average and barely 3% in the United States. So, there is a margin of safety in Asia.
Another investment would be State Street’s emerging Asia ETF, GMF listed on New York. Or, if China is the target, FXI, the iShares FTSE/Xinhua China 25 ETF, which tracks a basket of Chinese companies listed on Hong Kong. We also own the PowerShares India ETF.
On the Asian theme, one of our core holdings trades on Hong Kong; it’s called the ABF Pan Asia Bond Index Fund. The Euro and commodity dollars have taken the brunt of adjustments vis-à-vis the U.S. dollar during this decade. But much of those adjustments are done. As the hard bloc countries continue to prosper, currency gains should shift to these surplus countries; namely, to the currencies of Asia and other select emerging markets. The ABF Pan Asia fund invests in local currency-denominated bonds issued by emerging Asian governments. It’s a very good portfolio diversifier, with low correlation to both G7 bonds and their own equity markets. Other benefits include improving credit quality and liquidity and, of course, potential for large currency gains. The Holy Grail in running diversified portfolios is to find low or negatively correlated asset classes with attractive risk-return dynamics, and ABF is one that fits the bill. It really helped us outperform our composite benchmarks in 2008.
TGR: So we’re looking at overweighting major caps. We’re looking at international emerging markets, particularly India and China. What other sectors would you recommend that investors be holding or investing in?
TM: The other theme we’re working on is global currency debasement. The Federal Reserve has indicated plans to buy long-term Treasury Bonds as they did in the Great Depression. Bernanke has even hinted at buying corporate bonds. All of these actions are ultimately inflationary. So we are entering an era of massive currency devaluation. This will drive investor flows to assets that can preserve wealth, mainly gold.
Recent purchases seem to be less speculative and more investors seeking a safe have to protect wealth. We see that in record purchases of gold bars and coins, and more investors taking physical delivery once their futures contracts expire. January ETF figures show a record monthly inflow of 105 tonnes into gold-backed ETFs worldwide—that brought total ETF-owned holdings to an all-time high of 1,317 tons. About 1,000 tons, by the way, is in the U.S.-listed gold ETF, which is GLD. How do we currently invest in the gold sector? We’re heavily overweight gold stocks—that’s played through GDX or XGD. GDX is the Market Vector’s Gold Miners ETF and XGD is the iShare Global Gold Index, which is listed in Toronto.
One reason gold mining stocks had been underperforming other commodity stocks in the last few years was the cost of production rising so dramatically. That situation has reversed and industrial commodities basically fell off a cliff last year while gold held steady. If you’re a student of the Great Depression, you’d know that the gold stocks did incredibly well during that period, which was due to declining costs rather than an increase in the nominal price of gold. Profit margins for gold companies in the 1930s, such as Homestake Mining and Dome Mines, soared during that period as industrial demand declined and the cost of production fell.
Today’s gold majors, such as Goldcorp (TSX: T.G, Stock Forum), Newmont Mining Corp. (NYSE:NEM, Stock Forum), Kinross Gold Corporation (TSX: T.K, Stock Forum) and others—which are all held within XGD or GDX—are in a similar position that Homestake was in 1929. So, as ETF investors, we simply buy the basket of gold stocks and invest in the blue-chip gold stocks that way.
We’ve actually been debating this because a lot of folks are saying that gold stocks have risen too far too fast. That might be true in the short term; we could see a technical pullback. Gold stocks are up about 130% since their October lows, but they’re still about 35% below their highs in 2008 and that’s during a time when gold remained firm and industrial commodities declined drastically. So we continue to be positive on the gold mining sector and have held gold stocks in our portfolios as kind of a core opportunity position for some time now.
TGR: You mentioned in the ’30s the healthy profit margins resulted from lower mining costs. But the whole rally toward gold now seems to be based on anticipation of the price of bullion going up. Do you expect these gold majors to produce better than the average returns even if the price of gold does not climb?
TM: Yes, exactly. Even if the price of gold stays where it is, we’ll see some great earnings come out over the next few years. If you look at the ratio between industrial commodities and gold, gold is at a record high. Now, most industrial commodities are now approaching their average cost of production, so they’re probably near a cyclical bottom. But we don’t see a massive industrial commodity bull market just yet, because the global economy is so depressed. So as it stands now and likely for the next few years, we have an incredibly profitable environment for gold mining stocks.
TGR: So your approach is to look for the gold mining stocks rather than the gold bullion for more upside potential?
TM: Basically, we’re not picking a Goldcorp or a Newmont or a Kinross, one over the other. We’re just going to buy all of them as an index and limit the individual company risk. We hold XGD and GDX for all our client portfolios now. We have owned XGD for our clients since its inception in 2001.
TGR: You’ve had nice returns on that one.
TM: And we also had a few years during which it was not doing much!
TGR: Are you also putting GLD into your investor portfolios?
TM: We held GLD for a long time and sold it when gold was at $910 last fall. That decision was based on the fact that the ratio of gold to gold stocks clearly favored investing in the gold stocks, and we did feel the industrial commodities could have further declines. Now, we’re looking at the gold stocks as a high beta play on gold. It would be great if gold bullion rallied, too, but I think if gold bullion rallies, it’s likely the industrial commodities will rally as well. Again, we are focusing on profit margins for gold mining stocks.
TGR: If gold retreats to the $700s, which is was not that long ago, would these still be profitable companies that won’t need to go out for capital?
TM: Most definitely. I’m not speaking to specific companies, but a lot of the costs of production are for the majors are now much lower than the $700 area.
TGR: Obviously, all the stocks went down in October when all the markets crashed. Why haven’t these rebounded faster, given what you’re saying, if they’re basically going to outperform even if the price of gold goes down?
TM: The gold stocks have rallied hard but lower costs will translate into better earnings, even in the next few quarters. If you look at the earnings of Homestake Mining and Dome Mines in the ’30s, they increased astronomically and that was only into 1931 and 1932. Are you saying that because industrial commodities have fallen so fast and gold has not, you would think the gold stocks would rally more?
TGR: Not so much that as the fact that so much money is sitting on the sidelines. If the gold majors represent a higher-than-average return in this environment, why hasn’t the money gone into those at this point in time since there’s so little else to invest in?
TM: It’s a good question, but I think when the earnings come through that you will see a lot more money moving in there. If you look at GLD, the bullion-backed ETF listed on New York, it’s absolutely crazy how much money has flowed into that ETF. I think people are moving into it and, again, as more of a wealth preservation measure rather than a speculation on getting a double.
Gold stocks are already up 130% from their October lows, so they’re doing incredibly well. That’s why a lot of people are saying it’s too much too quick and so gold stocks are due for a fall. We do not emphasize the short term and attempt to trade in and out of asset classes. We take a longer-term view. I don’t care what gold stocks do in the next month or two. Longer term, those profit margins will be there and we come again to the theme of protection against global currency debasement. It will be a race for economies to debase their currencies. Every country wants to stay competitive in global trade game and that’s the key issue.
TGR: You’ve identified a number of core themes for the overall portfolio. One is overweighting for the major caps, another is international, and a third is gold. Are you looking at any other major themes?
TM: All of our portfolios take a globally diversified, balanced approach and emphasize risk management as a central focus. A lot of folks are taking less risk now after the markets have tanked; you can see that in retail investors pouring money into money-market funds and institutional investors with extremely low equity weightings and high bond weightings. Merrill Lynch’s latest global fund manager survey represented a very, very bearish reading. In other words, professional portfolio managers are positioned very, very conservatively and are holding record amounts of cash and a record underweight to emerging markets and so forth. Investors always tend to react after it’s happened.
At this stage, our firm is progressively taking on more risk. In fact, we have as much risk in our portfolios now as we’ve had since 2003. We had been underweight equities and emphasizing quality over the last three to four years. Now we are gradually shifting back into risky assets. There are good values and yields are very decent in some markets.
TGR: Everyone’s been saying this is the time to buy. If you’ve got the cash and the aptitude, there are lots of good bargains out there right now.
TM: Most definitely.
TGR: Percentage-wise, how are you weighting the major caps, the international, and the gold stocks? Is it even across all three? Or how would you divide it up for the next year?
TM: We run nine different globally balanced portfolios, so the weightings differ in all the different mandates. Certain mandates have higher international content and certain mandates are a riskier in their nature. But, as an example, the fully global portfolios have approximately 7.5% in emerging Asian equity, up to 10% in the gold sector and the remainder is diversified in other global stock, bond and special situation ETFs.
TGR: Any other predictions or sectors you’d like to talk about?
TM: The global economy is going through significant changes, and ones that will have an impact on how investors should position portfolios. Many of the things that worked in the last two decades are not going to work now. The U.S. will no longer lead the economic world; nor will Europe. These circumstances call for putting on a different pair of glasses to look at the world. We’re going to see a shift of focus and that creates some very exciting investment opportunities.
Tyler Mordy, a key player on the Hahn Investment Stewards team (https://www.hahninvest.com/), joined the company in February 2003 after starting his career in the international investment arena with Deutsche Asset Management in London. Now Director of Research and Portfolio Manager as well as serving on HAHN’s Investment Committee, Tyler is credited with making significant contributions in the development of the firm's proprietary portfolio engines. He is engaged in bottom-up research of ETFs, top-down strategy development, investment policy and securities selection. Widely regarded for his expertise in the burgeoning ETF arena, Tyler is a University of British Columbia alumnus (mathematics and English literature) and holds the Chartered Financial Analyst designation.
Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.