Still Glittering

First Eagle’s funds, run by Jean-Marie Eveillard, 62, who is set to retire in 2005, and Charles de Vaulx, 41, who will take sole management control then, have demonstrated that a disciplined approach to value investing can succeed in any economic environment. The managers’ five-star First Eagle Gold Fund (SGGDX) is no exception. The fund’s assets have increased nearly twentyfold in the last three years, from $10 million in 2000 to $190 million in April 2003.

Investing in a diverse menu of gold plays including mining stocks, gold-linked notes, and bullion, de Vaulx and Eveillard have lowered their fund’s volatility (although de Vaulx admits it is still high) and have maintained a disciplined approach to investing. As bullion boomed amid international tensions last year, the fund’s net asset value more than doubled, from $6.27 in 2001 to $12.89 in 2002.

In the first five months of 2002, gold was trading at more than $325 per ounce, compared with its mid-1999 price of $250, de Vaulx explains. “We decided to switch out of some gold mining stocks and started to buy gold-linked notes, and then later bullion itself.” Gold-linked notes account for 13% of the First Eagle Gold Fund portfolio, and 16% of the fund is in bullion. “Those gold-linked notes were tailor-made for us. They have a one-year maturity and are leveraged one-and-a-half to one to the price of gold. So at the maturity of these notes, if the price of gold has gone up 20%, the redemption price would be 130% of par,” he says. Later in 2002, as gold stocks began to increase in price, the fund began investing in the metal itself. Bullion is leveraged at one to one, “so this is how we control volatility,” he says.

As of April 30, the fund had about 42% of its assets in foreign-based companies, and had a five-year annualized return of 10.7%. That compares with 0.1% for all equity sector funds and -2.4% for the S&P 500, according Standard & Poor’s. The fund also ranked fifth within the universe of 533 equity sector funds for the five years ended April 30.

De Vaulx likes to have maximum exposure to the gold market. To that end, he does not invest in gold mining companies that “engage in too much forward selling and hedging,” he says.

Though the fund’s year-to-date return was -9.46% through April 30, de Vaulx says he is not surprised. “We are down because the price of gold was strong in January, but as the idea of war with Iraq spread, the price of gold fell sharply in February and March,” de Vaulx says. “So the price of gold is now lower than it was at the end of last year as you would expect. And as the price of gold fell, bullion and gold stocks fell. If anything, our fund is down, but has held up better than most others for the simple reason that the gold-linked notes [we invested in] are leveraged and have not come down as much as the mining stocks.”

We spoke to co-manager de Vaulx about his fund’s performance, how gold behaves differently than other metals, and why he’s invested much of his own money in the gold sector.

Does your fund invest mainly in gold stocks? Our fund, which was created in 1993, invests mostly in gold stocks. Over the years we have had a little in silver-related securities, at most 5% to 6% of the portfolio. Once in a while we’ve had 2% to 3% in platinum or palladium securities. But it is first and foremost a gold fund, as opposed to a precious metals fund or a natural resources fund, which would include base metal and forest products.

Do you feel that precious metal funds, which have performed better in a low-return environment than most other sectors, are on their way down? Has gold’s run finally ended? I don’t think so. Starting in November and December of last year, the price of gold went through the roof, and as the crisis with Iraq started, many speculators–including commodity funds and hedge fund speculators–bought gold, thinking that a war could be favorable to the price. The war brought out a lot of speculators, whom we think bought gold for the wrong reasons. And as the war unfolded, all the speculators sold their gold positions. As a result, the long-term fundamentals for gold are encouraging. I have found that as the dollar has resumed its slide, the price of gold has started to act better. Historically there is a pretty good inverse relationship between stocks and gold. We have been in a major bear market for stocks for three years in the United States, and we don’t think U.S. stocks are going to rebound sharply. We think there is a potential for more investment demand for gold.

Please talk about how the different precious metals behave. To generalize, platinum and palladium behave mostly like industrial metals. They are linked to the economic cycle, whether it is in the form of jewelry demand, which impacts platinum, or automobile manufacturing, which impacts both platinum and palladium. Gold itself is hybrid in a sense that the bulk of demand has been in jewelry, as opposed to investment. In the mid ’70s, however, the price of gold went up sharply due to investment demand. Historically, silver was used as money, and as in the case with gold, there is a fair amount of silver used as jewelry. Fifty-one percent of the demand for silver is linked to the photographic industry, as it is used for film. And photographic and photo usages are somewhat linked to the world economic cycle. So silver is somewhere between gold and platinum and palladium. Silver and gold have both jewelry demand and investment demand.

And jewelry demand in itself is somewhat ambiguous. In places like India or the Middle East, people buy gold as jewelry, but unlike the United States, the retail price of a gold necklace is at most worth 10% or 15% more than the gold content. Many people who buy gold jewelry in Asia or the Middle East have in the back of their minds that this is also an investment.

How do you handle risk in a sector where individual stocks can be very volatile? The way we handle risk for all our funds is by having a value approach to investing. We are very price-sensitive. Whenever we buy a stock, we try to assess what a company’s intrinsic value is, and then we try to find securities that trade below that intrinsic value. When you do this, you create what Benjamin Graham, the father of value investing, called, “the margin of safety.” It gets trickier to do this with gold mining stocks because they typically trade at a premium to the present value of their gold mines. Another way of reducing risk is diversification. When you run a specialized fund like our gold fund, it is harder to have hundreds of securities like we do in our global and our overseas funds. Nonetheless, our gold fund has around 66 positions, and, in fact, the real diversification is higher than that because in addition to diversifying our securities, we own bullion outright. Bullion makes up about 16% of the portfolio.

Currently, First Eagle Gold Fund has 57.76% in U.S holdings and 42.24% abroad. How do you determine the mix of the fund? Is it simply a reflection of where mining companies are domiciled? Yes, especially since a company might be domiciled in the United States but the bulk of that company’s gold mines might be located outside of the U.S. As an example, we own Freeport-McMoRan Copper & Gold Inc., a New Orleans-based company that has a giant copper and gold deposit in Indonesia. Even though it is a U.S. company, the reality from a risk standpoint is that it is Indonesian. Likewise, we own another U.S.-based company with mines in Nevada, but they also have many mines in Mexico, Peru, and Australia. So where a company is headquartered is largely irrelevant. Conversely, when we look at each company, we do pay attention to where the assets are located. Some gold mines are in South Africa, which entails some political and health risks. To minimize risk, we pay attention to where the mines are located, and we would obviously be reluctant to have too much of our portfolio invested in companies in one single area.