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CEF INSIGHTS PODCAST: ASA’S MERK INVESTMENTS ON GOLD SECTOR OPPORTUNITIES

 

With inflation and geopolitics fueling volatility in investment markets, what opportunities should investors look for in the gold and precious metals sector? In this CEF Insights Podcast episode, Merk Investments' Axel Merk, President and Chief Investment Officer, and Peter Maletis, Portfolio Manager, share views on the sector›s outlook and opportunities and impressions of the rise of digital assets. 


Merk Investments focuses on gold, precious metals and minerals, and is the Advisor to ASA Gold and Precious Metals Limited (ticker: “ASA”), a closed-end precious metals fund. 

Featuring:

Axel Merk, Chief Investment Officer at Merk InvestmentsAxel Merk
President & Chief Investment Officer

Merk Investments Logo

Peter Maletis, Portfolio Manager at Merk InvestmentsPeter Maletis
Portfolio Manager

Merk Investments Logo

 

Listen here:

Podcast Transcript:

CEFA:

Welcome to CEF Insights, your source for closed-end fund information and education, brought to you by the Closed-End Fund Association. Today, we are joined by Axel Merk, President and Chief Investment Officer, and Peter Maletis, Portfolio Manager for Merk Investments. Merk Investments is the investment advisor of ASA Gold and Precious Metals Limited, ticker ASA. We're so glad you both can be with us.

Axel:

Great to be with you.

Peter:

Good to be with you as well.

CEFA:

Axel, since we last spoke in May, inflation has become a more significant issue. The Federal Reserve is expected to shift from its highly accommodative policy and geopolitical tensions are increasing. Your firm regularly publishes economic and market research. What is your view on the US and global economies, as well as your expectations for 2022?

Axel:

Well, we are quite concerned about inflation, and it's not just that inflation has been high. What many people don't appreciate enough in my view is that inflation is a process. Think about coming to a stop at a red light. When the light turns green, meaning when the supply chain issues are resolved, not everybody gets going at once. And so similarly, when people hear about inflation, everybody wants to somehow make up for it. That means they'll ask for higher wages, they'll try to push up prices. So the longer this lasts, the more the risk that this is going to get out of control. And the Federal Reserve even now is priced in to maybe go to neutral. And that's just not "Good enough."

Now all of that is paired with the growth outlook, which on the one hand we have this reflationary environment where especially Asia hasn't opened up yet and we should get a boost, also inflationary pressures. But at the other end of the spectrum, things feel very much "A late cycle." And so that's a very, very unique environment that things have been as condensed as they are and they make for some very interesting investment.

CEFA:

Merk Investments focuses on gold, precious metals and minerals. Can you discuss your outlook for this sector, given your thoughts on the broader economies?

Axel:

Yeah. Several things to think about. One is inflation. It matters what the forward looking inflation expectations are. We think the Federal Reserve will not be too "tight." And so even though real interest rates, meaning those net of inflation have been coming up, they continue to be negative. And when you don't get paid to hold cash, then something like gold can compete in our view quite well.

The other one to think about is financial conditions. The whole point of raising rates is to "tighten financial conditions," which is a code word for increasing spreads of junk bonds and whatnot. And the reason that's relevant for the precious metal sector is because especially junior companies are in notorious need of financing all the time because they need to develop the next stage of their growth.

Now we think that the Federal Reserve is trying to be at least very, very careful that as they, "tighten," that they don't overdo it in the sense they don't want to have the taper tantrum. They don't want to provide an environment where financing becomes impossible. And the market already prices in that the Federal Reserve is going to ease again in about two and a half, three years. And so it's an environment where we think there are lots of opportunities They are certainly not risk-free as the sector is, but there are lots of opportunities for the sector.

CEFA:

Peter, you manage ASA Gold and Precious Metals Limited, symbol ASA, which invests in a portfolio of companies in the precious metals and mineral sector. For investors looking for exposure to this sector, how does this type of portfolio differ from investing in the actual metals, maybe through an ETF?

Peter:

So the way we approach the investments in this sector is that the primary investor in ASA is somebody that already has a positive inclination towards gold and wants exposure to gold equities in their portfolio. So while we have a fundamentally positive view on the gold price over the next near term, we believe that you get better leverage to the gold price by investing in a basket of mining equities. And so in that way, we hope that the investors can get better performance of the commodity. And then in addition to that, some of the ETFs are a little bit top-heavy in some of the larger names, which just trade relatively in line with the gold price and the larger equities in the portfolio. We're looking for smaller names and companies with growth prospects, and also catalysts that are not contingent on an appreciating gold price. And through that we get leverage to the gold price versus other portfolios and I hope for out-performance in that timeframe.

CEFA:

Peter, we spoke about the US and global economies earlier. How does this outlook impact the way you structure your portfolio?

Peter:

We look at the portfolio... Again let's kind of focus on the fundamentals, company specifics and rather than focus on the economy in general. Again, a lot of our fundamental analysis pushes us towards investing in these companies that have the catalyst. So at the end of the day, we're just looking for company-specific catalysts that drive out-performance. The economy as a whole doesn't drive the primary decision to invest in the sector.

CEFA:

Are valuations in the precious metal space at attractive levels?

Peter:

We continue to believe that throughout the sector, the valuations are great. The companies over the last five to 10 years have done a really good job of de-leveraging the balance sheet, focusing on cost cutting and generating significant free cash flow. On the current gold price above $1,800 is generating significant cash margins and the companies have paid down most of their debt, increased their dividends, and looking for continued growth in looking for new projects.

One of the ways we're taking advantage of that is we're looking for companies that have not only positive cash margin and a significant free cash flow generation, but also have a growth profile that is continuing to increase over the next five years. Some of the larger companies have relatively flat growth profile over the next five to 10 years. And it's our opinion that these companies will need to supplement their production profile with new projects and exploration. And so we're investing in some of the smaller cap development and exploration names that will hopefully be the future growth for these companies.

CEFA:

Where do you see the best opportunities among precious metals companies?

Peter:

Again, we believe that the exploration and development companies have the highest risk reward in the sector. And so that's where we have a significant portion of the portfolio invested right now. We also are looking at some of the mid and small-cap producers that have the growth to outperform the larger cap names in the gold sector.

CEFA:

With the significant developments in the electric vehicle market, are you finding that other metals like lithium and cobalt are taking investor attention away from precious metals or is this interest expanding the investor base for commodities?

Peter: 

I think the commodity sector in general has been expanding and there's a lot of people focused on green metals and lithium and cobalt like we're talking about. I do believe that is a larger investment pool as you create a bigger supply demand case for some of those commodities, that being said, I think that's a different investor than the investors that look at gold and precious metals.

And so while it may take some attention away from the precious metals, people that like gold are usually the ones that'll be focused on our sector and less inclined to differentiate between lithium and cobalt and other commodities versus gold

CEFA: 

Axel, in the US, prices have been rising significantly throughout the economy and investors often look to real assets for inflation protection. Do you believe an allocation to equities of companies in the precious metal sector can provide some inflation protection for an investor's diversified portfolio?

Axel: 

Pretty much all investing we do outside of cash in some ways is motivated of course, to try to "beat inflation and retain purchasing power." And different investors choose to go about in different ways. What the gold mining sector in particular is offering is on the one hand, something that's more specifically focused on inflation because the price of gold and gold mining is often linked to inflation expectations and real interest rates.

And the other one is of course that it has a fairly low correlation to so-called risk assets to equities. And what that means is that if you're concerned about overall valuations in the markets, then it is another reason to diversify. Now we "sweep that up", Peter referred to it a few times now, by looking for special opportunities by investing in these small exploration companies that we often help to "institutionalize" them by providing them funding at a stage where the bigger players are not yet able to provide funding to them and each time rather than having a dilution that would potentially reduce the value of these companies, because these companies get funding and can make it to another stage in their growth, they often appreciate further in value.

And so we are looking for these company-specific opportunities to add value, and of course, the extent we do that obviously also helps on beating inflation. And so it really depends on what the investor's looking for. The risk profile of gold mining is of course very different from that of many other equities, but we believe investors may want to consider it as a diversify in their portfolios, yes.

CEFA:

Cryptocurrencies have again demonstrated tremendous volatility, but the market for digital assets continues to expand with non-fungible tokens or NFTs. Some investors see digital assets as a store of value, while others see it as a purely speculative investment. What is your view on the rise of digital assets and their place in investment markets?

Axel:

The context for many of these is that we've had financial repression for an extended period. People are desperate to do something to be out of cash. And so it's not surprising that there are many, let's call them phenomena in that context. Some of them will fail. Others may make it. And that's part of what we see when interest rates go up and we see who has been "swimming naked," so to speak when the tide goes back out.

I have in the past, compared some of the activity in the crypto space to Netscape. The internet is certainly still around, but Netscape is no longer. I do think there is very significant value in the decentralized ledger technology, whether any one of the "Cryptocurrencies" is the solution, I have my doubts on many of them, but regarding what it means for investment is that a lot of the speculative money has made it to the meme stocks and some of those cryptocurrencies, which actually has reduced some of the volatility in the gold and gold mining space. And so in that sense, it's a healthy development.

Over time, I believe that market as much as any other market will mature. And when we have this conversation in a year or two, again, we might talk very differently about some aspects of the crypto space.

CEFA: 

Axel and Peter, thank you so much for taking the time to join us today.

Axel: 

My pleasure.

Peter: 

Thanks for having us.

CEFA: 

And we want to thank you for tuning into another CEF Insights podcast. For more educational content, please visit our website at www.cefa.com.


Audio recorded on February 16, 2022.

The views and opinions expressed in the replay are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on factors such as market conditions or legal and regulatory developments. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible. This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. Shares of closed-end funds are subject to investment risks, including the possible loss of principal invested. Closed-end funds frequently trade at a discount to their net asset value (NAV).

 

 

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