By Toroso Investments

After recent years of consolidation, gold and precious metal mining ETFs are up about 30-40% YTD, which is a great set up for investor FOMO. To explore this possibility, the ETF Nerds have invited Otavio “Tavi” Costa  @TaviCosta into the Portfolio Manager Hot Seat during the Get Think Tanked Happy Hour. Tavi is a Portfolio Manager from Crescat Capital and is very well known on social media for his charts and graphs. To prepare for the call, here is a link to listen to a summary of a recent 30 minute presentation. As an activist and hedge fund manager, Tavi is anything but passive in his approach and his passion to make his case.

Gold is often viewed as a hedge against macro-economic weakness, inflation, and currency volatility. Investors and advisors may also be interested to learn that revenue growth from higher prices makes for very strong fundamental momentum trends for this sector. Moreover, after years of holding back on cap expenditures, free cash flow by the miners is, arguably, finally set to show meaningful growth that could lead to industry consolidation, or simply favorable conditions for additional drilling.

The disparity of performance returns in the gold mining ETFs is wide and reflects how structure matters. To highlight this issue, we use the ETF Think Tank Comparison Tool. Note that there is a 42% overlap between the two largest, VanEck Vectors Gold Miners ETF  (GDX) and VanEck Vectors Junior Gold Miners ETF (GDXJ), and the next closes ETF is the iShares MSCI Global Gold Miners ETF (RING), at 27%. The US Global GO Gold & Precious Metal Miners ETF (GOAU) has only a 9%, and is highlighted because of its outperformance and emphasis on the royalty companies. Some critics of the high-risk mining industry see the royalty companies preferred return stream status and better business model as a better access point to the gold trend.

Gold Miners FOMO Figure 1

Gold Miners FOMO Figure 2

Central Banks and FOMO: Are Tavi’s Points New, or have Conditions Changed?

  1. Tavi sets the rational for being long the miners as follows: Central banks are artificially leading to credit mispricing with very low or even negative interest rates, and creating excessive optimism around precarious fundamentals conditions.
  2. Bond volatility reflects complacency, but in the “MOVE Volatility Index Chart,” he highlights concern. He argues that this makes broad markets vulnerable to the degree of change against a backdrop of relatively high broad stock market multiples. When change occurs, valuations will hold up where free cash flow is most sustainable.
  3. Gold prices should hold up because of the supply/demand imbalance, expectations for inflation, and global Central Bank support.

Gold Miners FOMO Figure 3

Stock market performance is questionable, led by technology stocks whose valuations are driven by momentum of expectations. Broad stocks have done nothing, but become more expensive. The scatter gun approach may not work in the future? Growth stocks have held up – driven by technology and certain specific niche themes that are aligned with market dynamics. Thematic investing is the future because it allows the investor to capture specific alpha generating growth trends as markets are changing. The performance by precious metals is evidence of this fact, and a breakdown of the 167 thematic ETFs will follow in a future Weekly Blast about ETF Innovation.

Gold Miners FOMO Figure 4

In the past, we have written about the high expectations for Apple stock, now worth $2 Trillion. However, Tavi’s Free Cash Flow Estimate chart further drives the point about vulnerability. Note; Apple reports financial results on October 29th. Some further details about Apple’s valuation and free cash flow can be found in the Distillate Capital Third Quarter Letter (DSTL).

Gold Miners FOMO Figure 5

Questions, Discussion and Debate for Get Think Tanked this Week:

  1. Powell is committed to low interest rates and increasing the velocity of money to accelerate inflation. The move index mostly has traded in a narrow range. What might be the trigger for the expansion of the range?
  2. If central banks like in Switzerland (SNB) and Japan (BOJ) can print money vs GDP on an almost infinite basis, why can’t the US central bank do the same? Doe this not mean that there is a lot of room for expansion of its balance sheet. (See first chart in the beginning)
  3. Gold Miners, as measured by GDX and GDXJ, are 85% off the bottom on March 19th, while gold is up about 47% and the QQQs are up 61%. How is it that the miners are not seen as a little “Bubbalicious”? Is straight gold a better play for these conditions? Where should multiples on the group be?
  4. The bear case about equity markets has been made by many. Can the miner go up further without the broad equity market going down?
  5. China – US Trade relations? Where does he stand?

Conclusion: Asking the questions is easy. The Get Think Tank Happy Hour is about dialogue and open mindedness combined with a little fun! Thank you Tavi for joining us. Insights have value!

Originally published by Toroso Investments