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Are there certain times during the economic cycle that investing in gold makes more sense than others? Gold and gold equities have largely flown under the investment radar over the last few years, but is it time to take another look at gold? Dave Richardson sits down with Chris Beer and Brahm Spilfogel to discuss what makes gold tick and their non-traditional team dynamic.

Transcript

Dave Richardson

There are people who swear by gold as an investment. You probably know one of them, a gold bug. Somebody who's always saying: "Gold's been around as a global currency for hundreds of years and will always be a store of value in a turbulent world." They always want to invest in gold and think it's the best place to be. There's others like many portfolio managers I've met through my career who say: "You know Dave, gold is best as jewellery." I'm Dave Richardson and welcome to Personally Invested. I think gold does make beautiful jewellery, but I also think that there's a place in your portfolio for gold, and there's some times in the economic cycle, an investment cycle, where gold makes more sense than others.

Dave Richardson

Is now one of those times? Dan Chornous, the Chief Investment Officer at RBC Global Asset management once told me that there are three conditions needed for a sustained rise in the price of gold. Those are a fear of future inflation, a weak U.S. dollar and a supply and demand imbalance. Things that are present somewhat in today's global economy. With gold and gold stocks being beaten down over much of the last seven years, is now the time to take a serious look for your portfolio at this precious metal? Or should we all just go out and buy some nice jewellery?

Dave Richardson

The best people I can think of to ask that question are Chris Beer and Braham Spilfogel, who head the team that manages RBC Global Asset Management strategies for gold and other commodities. They're a particularly interesting team because of their background. Although they're both portfolio managers by trade, Chris comes at it from a background as a geologist. He can get right down there in the mine with the miners, with a pic and shovel and know exactly what to look for to find out the true potential of a mine, in a mining business. Braham is more the pure finance guy, with years of experience in that area, but that combination has been incredibly successful if you look at their results working together over the last 15 years. I hope you enjoy our conversation.

Dave Richardson

So, Chris, Braham, I know you were a little surprised to get the invitation today. Not a lot of invitations for the precious metals and resource guys over the last few years. But I think we're at a point where this becomes a really interesting area for Canadian investors and really investors around the world to take a look at right now. Why do you think you're starting to get some more invitations to do speeches and podcasts and other things like that these days?

Chris Beer

I think you're right Dave, we've actually had some institutional interest as well, not quite ready to step in the water, but obviously gold and basically resources, since their peak in the fall of 2011, have had a bit of a rough road, and certainly there's been pockets of outperformance, but nothing really longer than three to four months of outperformance. But as a contrarian investor, or even a value investor now, gold in particular and gold stocks for the first time have very attractive value and strong balance sheets. And basically, the whole sector has now wedded with new management teams as well.

Braham Spilfogel

And gold, specifically the commodity has basically been in a sideways trend now for three to four years, and that's quite encouraging; it stopped going down. That's the beginning of a new cycle sometime in the future. That's something we're looking for to in the next period of time.

Dave Richardson

And this is traditionally something that when it has moved, it moves very, very robustly, in a way that you want to be involved in it. So, what do you think the trigger is? What do you think, what makes it much more attractive today than it was, you know, six months or a year ago for investors?

Chris Beer

Well, I just think the level of gold, as Braham mentioned, technically looks to have bottomed, you know, around 11.50, have gone sideways for a few years. The supply and demand fundamentals for gold are attractive but, really it's you know, gold is a currency and many of the factors lining up for gold, you know, such as interest rates rising, potentially inflation has started to pick up. The U.S. dollar seems to have peaked maybe, you know, three to five months ago. That's signs that those signs were evident in 2001-2002, and as you mentioned, you know, it turns quite quickly. You know at the moment, you know, we still see strong global growth and rising interest rates and that probably favors the base metals and oil, but, cause they're like cyclicals.

Chris Beer

So the late cyclicals, by definition are the last ones to move and they have moved. And now, you know, we're starting to see a fair bit of choppiness in the broader market and in late cyclicals, and so we wouldn't be surprised to see, you know, over the next six to nine months, more interest in the precious metals base.

Dave Richardson

Yeah, and we're looking at late, when you're talking about a late cycle you're talking about a point in time where if, you know, people are watching the news, they're seeing a little bit of talk about inflation and interest rates rising and an unemployment very low and that's what we're seeing as a backdrop right now.

Braham Spilfogel

And to add to that thought, when you think about, you know, what is the bond market discounting going forward? Or discounting three to four interest rate increases over the next year? At some point, this is when gold tends and gold stocks tend to do better, is when all the interest rate increases have the expectations for increases have been discounted, then, you start to talk about the gold cycle taking over from the base metal and oil sector and holds the late cycle increases that are going on that we're seeing right now.

Dave Richardson

Yeah, and it's not just that belief that inflation has to be at 10 or 12%, like it was in the late 70s, early 80s or even higher inflation that we had in the early 90s. There's a lot of different inflation environments, it just has to be that element of the potential for inflation there, right?

Chris Beer

Right, I mean we've done a lot of analysis on what makes gold tick, and if you try to, we've done the natural log of the changes and interest rates, the natural log changes and inflation rates, so trying to go into several derivatives of things that are typically in reverse relationship with the dollar, oil. We've analyzed that, but it's you know, every cycle is a little bit unique, but unfortunately for this cycle, basically for, I guess, mankind, is what we're seeing globally in the way of leaders. You know, leaders are becoming very populist, we've got President Putin in since 2000, President Xi in China's looking to be president for life. President Trump wants to be president for life. And obviously we have these horrible, potentially horrible trade wars.

Chris Beer

And the last time we've seen that, that was probably the inflexion point for true inflation in the 70s. And we're seeing that now as you mentioned with wage, wage is starting to pick up but if we start to put steel tariffs on it's quite a slippery slope where, you know, having gold in your portfolio as a little bit of an insurance hedge is not a bad idea.

Dave Richardson

Yeah, so you've got that political instability, you've got the, you know, slight risk of inflation, late cycle, potential weakness down the road of the U.S. dollar, supply/demand imbalance, central bank buying, and all coming together to make an environment that, you know, you should at some point start to see this move and that's the opportunity that we're kind of highlighting here.

Braham Spilfogel

And on top of that we've seen, you know, since 2011, we've seen the sector, the gold companies compressing their multiples. As Chris mentioned before, you know, the multiples are as low as we've seen them, ever, really. And so, we have a nice spring compression here. We don't know when it's going to lift sometime in the future, but we think it will lift sometime, and historically in our portfolios what we have seen is periods of sort of, you know, down, down periods or flat periods. And then we have massive lifts in the portfolio, you know, I won't say what amounts, but quite large historically and they're repeatable, they happened, you know, a couple of times each decade. And we've seen it in our funds and you know it's just a matter of time that we see that, very high outperformance, sometime in the future.

Dave Richardson

So, let's move away from the overall opportunity and talk about how you work together, because you're a unique combination. We've got Chris who is a geologist by trade. I am too, I got into the "Rocks for Jocks" class at U of T, to get an easy A. And the professor came in and said, you know: "Anyone who's in here, the jocks in here who are looking for an easy A, I know who you are and you better get out fast." So, I dropped out after one day. So, I'm not a geology expert, but you are. And you combine that with your finance background and obviously you come with an incredibly strong finance background, Braham. And you're able to bring these two things together. Does he take you down in the mines to dig around?

Braham Spilfogel

Yes, he sent me for a decade now he sent me to all kinds of different holes in the ground and I enjoyed some of those visits, some not so much but it's been a great learning experience, we work great together. Chris always says yin and yang, I'm not sure if I'm yang or he's yin but, we certainly enjoy, I enjoy it a lot.

Chris Beer

The good cop/bad cop or glass half full/half empty.

Dave Richardson

So, that's not a traditional background to have in the investment world, to have that geology background. What does that bring to the table do you think for you?

Chris Beer

Well, you know, we've been managing the fund the same way over the last, basically since 2000, when I started to get involved. And that's really looking at the small, mid and large caps. And it doesn't have to be a small cap to have a focus on geology or finances or, you know, we didn't mention we have two Jeff's on the team; Jeff Schok and Jeff Chang and Jeff Schok was, you know, recently promoted to Associate Portfolio Manager. He's an engineer, so it brings that element. I can, you know, typically what happens whether it's a large cap or small cap, I'll get excited about the geology. You know, Jeff will come in and say: "Well, Chris, you know this, we got to tame it down a little bit." And then Braham will come in and say: "Well, we also have to finance this thing." And that's kind of how we look at things, our

Braham Spilfogel

Portfolio Management, basically comes in as the third pillar. So, we put all three of them together. There's got to be a financial aspect, a fundamental aspect.

Dave Richardson

What's your perspective on that, Braham, having that geology background and an engineering background on the team as well, to supplement what you've done in your career as an investment manager?

Braham Spilfogel

Well, it makes it, it puts a fuller dimension to when we look at a company because we can have that perspective of yes there's free optionality, we look for free optionality in anything and actually we look for free optionality, a lot of our portfolios across..

Dave Richardson

Free optionality, what is that?

Braham Spilfogel

So, that would be for example what's the market discounting today in the stock, just to use simple numbers if we thought that, you know, a company was discounting 2 million ounces for example, but our research showed, Chris' expertise often will show that, you know, we think this thing has a high probability of being three or four million ounces for example. And, so, in our mind we're getting the one or two million ounces as a free option, and so, we will make the appropriate sized investment in that portfolio based on the size of the company and size of our portfolio and make that investment in the company. And it doesn't always work out, but often our probability or chance of success is higher because we have the geological expertise, we have the engineering expertise, and we have the finance expertise we can kind of put it together and say: "Well, if the stock's a dollar or you know, 50 dollars for example, that extra two million ounces for example is worth 20 or it's worth a dollar a share additional and we're getting that free optionality. We really like the companies that have free optionality.

Braham Spilfogel

That's often one area where we earn our, you know, higher rates return.

Chris Beer

And there's certain parts of the cycle where that's more evident, and, you know, I just did some quick math, you know, Braham and I have been working on it together 15 years each, so that's 30 and Jeff and, the two Jeff's are ten, so we got 50 in this space, that's 50 years of experience and while Jeff, the two Jeff's are a bit younger, still, what it allows us to do is look at a very volatile industry. We do use quantitative analysis as well as overlays, but I think having proprietary base on, this is something you can't capture on a Bloomberg download or pay, you know, for an algorithm. You know you have to have your own models. You have known which managements have the better chance of succeeding. These are things you can't necessarily write an algorithm for.

Dave Richardson

Yeah, and it really is a team approach that you use.

Braham Spilfogel

Yeah, and I think that's an important expression because there's no sacred cows as we say. You know, anybody on the team can say: "Well, this doesn't make sense. Let's question this. Are we really, you know, are we locked into this particular idea, are we making a mistake?" So, we do have a very rigid, I guess checkmarks that would make us, you know, get on to a project or get on to a company and get off, as well.

Chris Beer

Very pragmatic versus dogmatic, like, although Braham has been painted us the financial guy was just yesterday, there was a mining conference, one of the world's largest mining conference was in town, and one of our favorite, you know, small caps was there, and you know, we were, have identified it early, and so far, so good. But, you know, Braham is questioning: "Well, do we own enough of it in the portfolio?" So, he's saying: "OK, Chris, you have the exploration side, but, on the portfolio, if we really think this stock could do what we think it could do, maybe we have to upsize our position."

Dave Richardson

Yeah, it's a really, you know, I've known you for a while, it's a really interesting combination of skills. It's not something you see very often to have all those elements, the specific expertise and that team environment that really brings it all together. And, I mean, the results speak for themselves. You've had a fantastic track record, investing in this space.

Chris Beer

Well, it's certainly tough at the bottom of the cycle, but again, you know, Braham is, you know, we're very aware of what happened in 08 and in other market bottoms where we don't want to, you know, have our core competence diluted by trying to time the bottom of the market, in the sense of having more defensive large or mid cap precious metal names rather than some of our favorite small cap names, which, you know the liquidity obviously is removed, certain parts of the cycle, but then when that liquidity is demanded for, you know, growing small cap gold stock, as you said earlier, you can really get very strong quick moves in the space and we want to be positioned for that.

Dave Richardson

So, we started off with where I think we all agree there may be an opportunity here, it's starting to look a little bit more interesting than it has the last few years. You've talked about the team approach that you have, the wide range of talents within the team. The specific talents within the team. Let's bring it back and just close on the whole idea of gold and where it fits in a portfolio. So, you know there's some people who are gold bugs, they believe in gold, they always have an element of gold in their portfolio and a big chunk of it. There's others who say: "Gold is for jewellery and for making sculptures or statues or artwork or whatever it might be. And that's about the only place for it." Well, what do you really think that the place for gold is? And I assume you have gold in your own personal portfolio?

Chris Beer

Yes I do, but obviously, I also have a lot of eggs in the basket with this being my main source of income focusing on the sector.

Dave Richardson

When you're talking to your friends and family, what do you say? Why should they own gold in their portfolio?

Chris Beer

Well, you know, historically as I say, we've gone back since gold was sort of let free by President Nixon in the summer of 71 and over that timeframe, generally, you know, when you have a weaker U.S. dollar, the Reserve currency is weaker. There's a move towards gold. And frankly, gold is, as I say, is actually up quite a bit since, you know, it's nadir at 11.50. And even the gold stocks are up, but they've had trouble breaking out here, but generally if you look at just the inverse relationship to the dollar, rising inflation. You know as I mentioned, you know I mentioned this in a speech a little while ago, and I didn't think it would come true, it was about the time that President Trump was elected and I said: "You know, growing populism and trade, potential for trade wars would be positive for gold." And it has been. And you don't have to look any further really than bitcoin, because I've seen some bitcoin propaganda where basically, they've cut and pasted the first page of Franco-Nevada's annual report.

Chris Beer

And they try to say that, you know, fee of currency this and fee of currency that, but bitcoin, there's over 1800 bitcoins, so there's only 220 odd countries in the world, so, there's more fee of currencies in bitcoin in our view than currencies. So we do think, you know, what will drive and that some of these fundamental factors that once gold can, that Braham mentioned, get through the 13.50 level, and then were broke down through 1400, you know, three or four years ago. You know what will bring people back is certainly the price move first in gold, but secondly and probably more importantly, as Braham mentioned, the space is, you know, fundamentally attractive for I guess the first time in my investing career, with regards to price to cash flow levels or price to NAV levels.

Chris Beer

And the whole, you know, the industry has changed quite a bit with the focus on returns rather than growth. And it's a new phenomenon that we don't think is recognized.

Braham Spilfogel

Well, you know, I still think the old quote of having some insurance in your portfolio, gold is a good one, it still keeps your purchasing power, it hasn't done anything for the last, you know, since 2011 it's been down. But it has kept its purchasing power and it will continue to going forward. So when comes a day when we see a fair market once again in the broad markets, gold will show and earn its respect again and this will be probably the place to be or one of the places to be that will, you know, perform and hold its value, and that's the time when you want to have a little bit of insurance against some of the rest of your eggs in your basket, so to speak.

Chris Beer

But to your point, they are planting their seed here as a contrarian. Braham and I recently attended probably the world's most, well largest mining event, in February and there was a, you know, the well attended luncheon speakers were base metals and there was live polling, base metals versus precious metals. And before the polling, 85% of people present, and there was over 1100 people there, voted 85% that the base metals would win. And obviously we got synchronist globalized global economic growth, PMIs are rising, everything is happy, you know and then the gold guy got up and said he agrees, you know, this is a great golden era for base metals with electrical vehicle demand for copper. But he did show, as we try to mention here, gold's inverse relationship and over well, since 1970, you look at that period broken up in ten-year periods, gold and gold stocks have really put you out on the efficient frontier in investing, right?

Chris Beer

And, he just showed that inverse relationship and said that: "You know, if you think that China's not going to have a speed wobble for the next three years, then don't have any gold in your portfolio, but if you think that there's a chance that global growth is at, you know, potentially peak in the next little bit and that all the debt that we've raised to come out of this 2008 global financial crisis, is you know, free money, than sure. Put your vote down for base metals."

Braham Spilfogel

And like I think Chris mentioned, we've gone for four trillion dollars in debt to now 21 trillion dollars in debt. Seems to be fine as long as interest rates are low. We hope that they do stay lower for long periods of time, but they may not, and, gold will probably show its shine then.

Chris Beer

So, the final poll was 65% were saying: "Well, maybe my next dollar or some part of my next dollar should go into precious metals versus a pro-growth" because basically gold and a few other things are the only things that are inversely related to global growth. And, you know, Dan has alluded to this, and Eric Lascelles, clearly it has one of the longest economic expansions on record, not necessarily the strongest, but the longest, and debt propelled. You know, there is an argument to have a little bit of gold in your portfolio.

Dave Richardson

Great! Well, thanks guys, thanks for your thoughts.

Chris Beer

Thank you.

Braham Spilfogel

Thank you.

Dave Richardson

Thank you again for joining us on Personally Invested. If you have any other questions regarding the podcast, please go to the RBC Global Asset management website at rbcgam.com. We'd love to get your feedback on this conversation and ideas you might have for future podcasts that we tape with our Portfolio Managers or anyone interesting in the Canadian Investment Industry. Thanks again.

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