What drives the gold price next

Jupiter Gold & Silver fund manager Ned Naylor-Leyland looks at what could now influence precious metal prices after a volatile year. He also talks about how the portfolio is invested and why.

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Dave Baxter, senior fund content specialist at interactive investor: Hello and a very warm welcome back to our Insider Interviews series. 

I’m Dave Baxter here at ii and today I’m joined by Ned Naylor-Leyland, investment manager on the Jupiter Gold & Silver I GBP Acc (BYVJRH9) fund. Ned, thanks for joining today. 

Ned Naylor-Leyland, investment manager on the Jupiter Gold and Silver Fund: It’s an absolute pleasure.

Dave Baxter: So, Ned, gold and silver funds of different stripes have been very popular in the last year. I’ve been looking at yours, what makes it stand out, how are you different from the competition? 

Ned Naylor-Leyland: Well, I think what makes our offering stand out is that we’re not the same product. We own physical gold and silver, we own gold miners and silver miners, and we only invest in certain jurisdiction. So it’s not all benchmarky. We look for the best instruments in different subsets and blend them together. 

Dave Baxter: What is your mix when it comes to  gold mining companies, silver mining, and then physical? 

Ned Naylor-Leyland: Well, it changes. At the moment, we’re 50-50 between the two metals. We have about 17% in physical, slightly overweight silver to gold. But, yeah, through the entirety of the portfolio, we are 50- 50 between the two metals. And I like that because I think that it’s a sensible thing to access additional beta by using silver. We have a pretty different blend to other active or passive products. 

Dave Baxter: Lingering with that physical allocation first, for those who don’t know, how would you say that physical gold should behave differently to, for example, holding shares in gold miners? 

Ned Naylor-Leyland: Well, directionally they go the same [way]. You’re not going to see physical gold and silver going up with miners going down, that doesn’t happen. The issue here is how much beta will the miners have relative to the physical? Now, it does flex. You can see it as low as 0.8 or one times. In other words, they behave the same, but you can see it as high as four, five times, even more than that sometimes. 

The reason why that happens is because gold and silver are foreign exchange (FX) instruments. They live in that world. 80% of turnover in gold is FX. It’s not real gold, it’s the foreign exchange market, and that’s driven by real interest rate changes. 

Whereas the mining stocks are equities, and as you know, equities are highly sensitive to flow. So, that’s very much about participation. 

It interests me that you mentioned [gold and silver funds have been]very popular. Actually, investors - and here we’re here to talk about investors versus speculators - have really been absent. They haven’t participated in the rally we’ve seen. It’s been driven by hedge funds, CTAs [Commodity Trading Advisers]. It has been a macro trade that’s driven the price up. 

The long-only investor hasn’t really joined in yet. I think that will happen because the companies themselves are exceptionally profitable, very big and growing margins. And [they have] very low valuation metrics. So, they’re very attractive. But what we haven’t seen yet is the wider investment public say, ‘I need this’. 

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Dave Baxter: If we look at gold, there have been interesting questions asked of it in the last year. You could easily argue at the start of this year, that it’s been behaving more like a momentum asset, and then it had the big sell-off. And then, of course, we had with the conflict from March onwards in the Middle East. It wasn’t really behaving as a safe haven in ways some expected. 

Ned Naylor-Leyland: Well, that’s because people don’t necessarily realise what’s moving the price. The first thing to say is when we’re talking about the price is that we’re talking about price in dollars. We are here in the UK, and we should really be talking about it in sterling. But when investors think about it, they think about gold in dollars and what you’re seeking a safe haven from is debasement. And that’s what driven this momentum, as you quite rightly observe, the price was on momentum because that’s leverage. 

So, what you had was this cohort of speculators using margin, going heavily long debasement. And the reason why the price came down was deleveraging. So, it was the end of January, effectively all those leverage investors got a lot of trades wrong at the same time. One of them was gold. Silver was more of a retail version and the retail public were also using margin or effectively using margin by buying triple-leveraged ETF structures. 

Effectively, everybody still at the end of January was expecting debasement. This was still a theme. And then Kevin Warsh got the nomination [for Federal Reserve chair]. And for whatever bizarre reason, the market decided that was hawkish. So, this was a full trend reversal on one day from dovish to hawkish. This saw deleveraging. And as you quite frankly point out, all the momentum came out of it. 

I’ll reiterate to you that that is just one half of the market. It’s more important to price discovery, leverage and hedge funds, etc. This drives price action on a daily basis. But of course, the far bigger pot of capital is with investors. They weren’t in last year, they weren’t the year before, they’re not in this year, and they haven’t come yet. 

And you can see that most clearly through - I mean, there’s lots of ways of looking at it, really - the amount of physical held bythe big gold bullion ETF products that investors use. It’s as low as it was when the price was $1,800, $1,900 an ounce six years ago. That’s how little participation we’ve seen from investors. 

So, yes, at the moment it’s still principally a narrative momentum and leverage-driven trade, but those of us that feel strongly about the topic and think that everybody should own it, what we’re waiting for is the moment when the investor joins that. 

We think that there’ll be a moment where you’re going to have both. You’ll have the trader and the margin investor and long only coming together. At that point, you’ll see some quite fancy price action, I would imagine. 

Dave Baxter: What would you expect to see to drive the long-only investor back in? 

Ned Naylor-Leyland: Well, it’s not fundamentals or raw performance because otherwise they’d already be there. On every basic observable metric, people should already own these companies, and they should own bullion, but they don’t. The reason is because the investing public, particularly the managed investing public, has become very herded. You have your core portfolio and then you have a bit of extras. For the longest time, it’s been — I mean, I put it slightly glibly — double tech, triple tech, and quadruple tech dominating that part of the portfolio, and it still is. 

So, it’s obvious to me that until that starts to go down, we’re going to struggle to see a rotation from that into what is the best-performing part of the global economy, and I’m not exaggerating. Gold mines and silver mines are making more money than anybody in the world. They have been for a consistent period now, but it’s not the performance. 

So, I think it’ll be that split of performance. So, once other things start to do poorly, these things continue to do well. And the reason I would expect that to happen is because if things do start to go lower, the market will start pricing in cuts, because obviously a negative wealth effect of asset prices going down will make the curve more dovish. That drives gold and silver prices. So, you would slightly see an acceleration that way. At the same time, other parts of the equity market are going lower. 

So the answer...what I should have just said is a pain trade rather than giving you a full explanation, but basically a rotation caused by less good performance elsewhere. 

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Dave Baxter: So, you need to see enough of a tech sell-off in order to bring in the prospect of interest rate cuts and therefore kind of improve the outlook [for gold]?

Ned Naylor-Leyland: The thing is you can have a prospect of interest rate cuts independent of a tech sell-off. So, the whole thing will still continue to do very well. We get the cuts, but tech remains elevated. But if you get that tech complex starting to look less robust than it does right now, equity investors will want to know what’s the next thing? What’s the thing that I can have in my portfolio that is doing well? 

And the answer is, it’s already doing better. It’s just that people haven’t felt the urge or the need. Of course, there’s also that not insignificant point of huge gains, and people don’t particularly like taking gains and rotating, that I think is still a bit of a block from people coming in. 

Dave Baxter: And if we’re looking at movements of gold price and what we should expect in future, what are the key factors that investors should be monitoring? 

Ned Naylor-Leyland: Well, it’s what I said earlier. It’s just real interest rates - there is nothing else. There’s genuinely nothing else at all. I’m going to do what I always do here. People who know me will be chuckling, waiting for me to say something here, which is that there’s no such thing as the gold price. 

When you refer to the gold price, what you mean is the US dollar gold price, because if we’re talking about gold in sterling or Turkish lira, we’d still be talking about real interest rates. 

Now, the reason that people talk about the gold price, and it’s reasonable to do it in this environment, is because the US dollar gold price is the local currency, or rather the dollar is the local currency of the financial system. So, when we talk about the gold price, there’s this assumption that we mean in dollars. 

So, when you ask me what would drive it, it is US real interest rates and the expectation of US real-interest rates. Now, the gold pricing in Turkish lira is highly likely to continue to go higher because real-interest rate expectations in Turkey are relentlessly that way. Probably you can argue the same here as well, by the way. 

But it’s actually about the dollar, or US real interest rate expectations. So, the interplay between rate expectations and inflation expectations, and crucially, of course, the guidance from the Fed, because policy now comes so far after guidance. It’s shifts in guidance that make the difference, but it isn’t anything else. 

It is not central banks. It’s not, there are several completely false narratives that are repeated constantly on this topic, most importantly central banks.Physical gold is about 3% of daily turnover, it’s almost entirely irrelevant. It doesn’t drive the price. So, if you’re thinking about price, think about real interest rate expectations. 

Dave Baxter: What are the other false narratives you would want people to be aware of? 

Ned Naylor-Leyland: Gosh, there are so many. I mean, there were so many. One of the most important ones is when people think about investing in physical gold. I’m going to correct myself here. They’re thinking about investing, but it’s not investing. Physical gold is disinvesting. If you buy physical gold, you’re actually removing your capital from the market and from risk. You’re saying, ‘I don’t want to participate, I want my capital out. I don’t want it in sterling, I don’t want it in government bonds, I don’t want it in anything. I want to remove it.’

This is why central banks and governments hold their cash, their reserves, in gold. It’s effectively telling you that it’s goldthat’s at zero and currencies that go down. So, when people buy physical, they shouldn’t be making an expectation that they’re going to actually make a real return. It’s not like that, it’s the yardstick. 

That’s why central banks, and they’re not going to tell you this, by the way, that just happens to be the truth, and it’s a very important one because this also, in my opinion, makes gold miners and silver miners much more interesting because then with them, you’re making an active investment. 

You’re saying, I think that governments have continued to debase their currencies. And if you don’t think that, good luck. They are going to continue to debase their currencies. But I want an active view on this. I don’t want the passive disinvesting view, which is to buy physical. I want to have an allocation in my portfolio which is saying, no, this is clearly still going to happen and can potentially accelerate. And the best way to do that is through the mining stocks. 

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Dave Baxter: Turning, then, to shares in mining companies, where it can clearly be a volatile space, what factors are you looking for? 

Ned Naylor-Leyland: They are certainly volatile, there’s no doubt about that. I think that that’s a good thing overall, though, because you want that beta. People aren’t going to allocate huge parts of their portfolio to this asset class. In fact, the volatility in my view is your friend. 

But the first answer is to spread your risk. This is why running a fund is a much better way, or owning a fund potentially, of expressing ownership of these things than one individual stock. 

They have an option-style outcome for an investor, both good and bad, and at the moment, they’re still very out of the money. But if you think about them on an individual case basis, while some of them have idiosyncratic upside potential through drilling, exploration, maybe being taken over, generally, they carry a lot of idiosyncratic downside risk. 

Again, whether that’s the most unlikely which should be expropriation all the way through to missing analyst guidance, and therefore falling 20%. 

All these things have quite a lot of operating variables and risks. So, what one seeks to do is reduce those. Now, I would say ‘seeks to’, it’s not easy. They are very complicated businesses. They can be even more complicated if they’re in difficult jurisdictions. 

This is why we only invest in the Americas and Australia because, ultimately, they are complicated. They’re difficult to model and stay on top of. Therefore, those variables that lie beyond that, which you can’t get your arms around, I’d rather not wrangle with if I can manage.

Dave Baxter: Ned, many thanks for your time. 

Ned Naylor-Leyland: Absolute pleasure. 

Dave Baxter: And thank you for watching. As always, do let us know what you think in the comments, and if you like this series, do hit the like button and the subscribe button. Thank you, take care.