Mutual funds are probably the best way for you and your clients to mine gold mining shares. Precious metals mining is a rough-and-tumble industry. Single-stock risk is nosebleed high, at least for the small and mid-sized mining firms, which tend to operate just one mine, or a cluster of mines in the same area. And these areas, and the methods used to mine them, may be among the least palatable. There are always concerns with pollution and political corruption, especially affecting mining areas in developing countries. Make sure your client is comfortable with the notion of buying when blood is literally running in the streets. The smallest firms also have the highest risk that fraud may have pumped up the stock price.
Different companies are also affected by different currencies, by their blend of metals output, and differing policies on leverage and hedging. Finally, advances in technology can have huge effects on these markets, and can make a fund manager’s in-depth knowledge of the stocks highly useful in putting together a portfolio of mining stocks.
For example, palladium has long cost substantially less than platinum or gold. Because it was about half as expensive as platinum, auto manufacturers spent a lot of money figuring out how to use it to replace some or all of the platinum in their catalytic converters. But with the new demand from autos, the price of palladium shot up to where it exceeded that of platinum by 70%. (The move was also partly a speculative bubble, fueled by this same increase in automotive demand.) But last year the bubble popped and industrial demand for palladium crashed, partly due to economic slowdown, but even more so from continued improvements in the technology of catalytic converters, to work well with less metal. (There also was nothing keeping people from switching back to platinum in their converters, albeit with a considerable lead time for any such change.) Since platinum and palladium peaked in January of 2001, platinum is down 14% (to $640 as of June 10, 2002), while palladium is down 69%. For the same period, gold prices are up 22%, and that’s because with gold, investment demand and jewelry demand are both more important than industrial uses.
For advisors and clients urging us to pick precious metals stocks, that can make a big difference in the bottom line. If you didn’t, for example, know that Stillwater Mining (SWC) produced primarily palladium, with about 30% as much platinum, and much lesser values of gold, silver, rhodium, and baser metals, you might have just bought it as part of a general “precious metals” portfolio, when you were thinking gold. Needless to say, while most precious metals stocks are up over the past two years, Stillwater is not. (To be fair, we should point out that Montana-based Stillwater is the only major source of platinum and palladium outside South Africa and Russia, and its stock could, under different industry scenarios, be a sector leader.)
For all the above reasons, mutual funds make sense for precious metals investments. But, as in mining, there are precious few gold funds, and among them, only a few are worth their weight in gold. Not counting up different share classes of the same fund, and the tiniest funds for which quotes are hard to come by, there are just over 20 mutual funds invested in precious metals. All told, these funds’ assets recently totaled $3 billion. That’s less than a thousandth of the money found in all of the U.S.-sold equity mutual funds.
Fidelity Select Gold (FSAGX)
One of these funds is Fidelity Select Gold (FSAGX). The fund was started in 1985 as Select American Gold, to distinguish it from Fidelity’s Select Precious Metals (primarily a distinction that mattered to investors who wanted to avoid South Africa in those days of apartheid). The two funds merged in February of 2000, and you might care to note that Fidelity’s gold-fund management experience actually goes back to 1981 at the old Precious Metals fund.
Select Gold’s manager, Neil Marotta, has run the fund since April of 2000. That’s a fairly short tenure, but he managed Select Industrial Materials from April through December of 2000, and was a Fidelity analyst covering Canadian companies from 1997 to 2000, and both of these areas have significant overlap with Select Gold.
Marotta is more interested in the bottom-up analysis of mining companies than the overall story for gold. He focuses on mining companies that have proven deposits of high-grade precious metals ore, as well as firms like Freeport-McMoran Copper & Gold, whose diversified mining operations produce gold in conjunction with baser metals. As he’s said to us, “Grade is God in gold. The most important asset a company’s got is how much gold there is on a per-ton basis. A very high-grade gold mine can translate into a cash cost of around $60 an ounce. You can’t really go wrong when you’re selling the commodity for $280.” As an example, he notes that “Meridian has a very high silver content in their ore. The revenues they get from silver can be applied against their cost and bring their cost for gold to well under $100 an ounce.”
In the fund’s latest annual report, Marotta pointed to Meridian, Agnico-Eagle and Goldcorp (recently his second-, third-, and fourth-largest fund positions) as typifying his “focus on medium-capitalization mining stocks of companies with substantial free cash flow and a low-cost structure.” He pointed out that his largest position, Newmont Mining, had just purchased Normandy Mining and Franco Nevada Mining at “favorable prices,” helping Newmont to lower its costs and making it one of the world’s largest mining companies. The fund, which is sold for a 3% sales load, had $750 million in assets at the end of May (a big pop-up from $535 million just a month earlier). And while we all know that sales loads are not high on most clients’ lists, as long as you keep the money at Fidelity you won’t have to pay the 3% again to move into another load fund. (Fidelity’s Select funds also charge an early redemption fee, but it’s a modest 0.75%, and only applies to shares sold within 30 days.)
Fidelity Select Gold is quite a concentrated portfolio; while it recently had 47 stock holdings, its top 10 positions amount to 67% of assets.
In addition to Fidelity’s Select Gold, at least one other option is worth a look: Vanguard Precious Metals (VGPMX) was launched in 1984 and recently had $555 million in assets (Vanguard’s shareholders do much less trading, meaning more stable asset sizes at their funds). Low annual turnover–17%, and it’s been as low as 2% in previous years–means the fund’s management is semi-passive, but that has not prevented it from attaining an excellent performance record, in part because it allows for a rock-bottom expense ratio (0.65%). Vanguard’s fund tends to hold slightly more value-oriented shares than Fidelity’s Select Gold, so even though Vanguard’s fund currently has just 24 stock holdings, it has tended to be about 10% less volatile than Fidelity’s since 1996, when Vanguard manager Graham French took over. For what it’s worth, the two funds are about tied for their 3-year returns, Vanguard leads for 5-year returns, and Fidelity is ahead for 10-year returns. Vanguard Precious Metal is sold without a front-end sales load, but does have a 1% redemption fee on shares sold within a year of purchase.
Indexes, ETFs, and Closed-End Funds
Tracking performance is also not a simple issue. There are three major indices covering the gold industry (not counting several niche indexes on the Toronto Exchange), but all of them are problematic. The prevalence of foreign stocks in the sector, and the common association of precious metals with base metals like copper, make it hard to decide where to draw the line when putting together lists of stocks for a gold index. Also, the indexes each have fewer than 10 constituents. All three include Newmont Mining, but each also excludes some obvious, relatively large potential positions. The indexes are: the Amex Gold Bugs Index (HUI); the Philadelphia Gold & Silver Index (XAU); and the CBOE Gold Index (GOX). (Depending on your quote source, you may have to precede the three letters with a ^ or $.)
Regular readers of this column know that we’re generally in favor of exchange-traded funds (ETFs) for investors interested in index investing. (ETFs act like index funds, generally with rock-bottom expenses and minimal taxable distributions.) Unfortunately, in the precious metals area the only ETF available is the iUnits S&P/TSE Canadian Gold Index Fund (XGD, or XGD.TO), which trades on the Toronto exchange, and is priced in Canadian dollars. You client probably can’t buy it in his or her brokerage account as easily as a domestic security, but your broker’s international desk can accommodate such a desire. But do you want to? The XGD is not very diversified, holding just eight stocks, all of them based in Canada: Placer Dome and Barrick Gold (each at about 21% of the portfolio), Goldcorp, Meridian Gold, Agnico-Eagle Mines, Kinross Gold, Glamis Gold, and IAMGOLD. You can get more information at www.iunits.com.
Among closed-end funds, the Central Fund of Canada (CEF) is, in fact, a precious metals bullion fund. It was recently selling at close to a 20% premium to net asset value. (If you want to buy gold and silver bullion and overpay by 20%, send us a copy of the letter informing your clients you did just that.) Despite the fund’s name, CEF is available on the Amex. Dundee Precious Metals, however (DPM or DPM.TO), trades on the Toronto exchange. It has long been selling for a discount of just over 20%. While there’s no guarantee that the discount will ever narrow, it beats paying a big premium that may be erased. The fund recently had 78% of assets in Canadian shares, but also has positions in the U.S., Peru, and Australia. Dundee Precious Metals has proven more volatile (risky) than the Vanguard and Fidelity fund offerings, but it also has a performance edge for short- and long-term periods. Despite the “ETF” name of the site, a good place to get information on this and other closed-end funds is www.etfconnect.com.