Jordan Eliseo is Senior Investments Manager and Head of Listed Products and Investment Research at Perth Mint, with over 20 years of experience in financial services. Owned by the Government of Western Australia and operating under an explicit government guarantee, Perth Mint distributes about $18 billion of precious metal products annually. Its gold Exchange Traded Fund (ETF) on the ASX uses the code PMGOLD.
GH: Many investors are looking for gold exposure, but how should they choose between the three alternatives of investing in physical gold, a gold ETF or shares in a gold miner?
JE: There are pros and cons to each. The easiest to separate from the others is the gold versus gold miner debate. It’s a fundamentally different risk-return profile. While there are times in the cycle where well-run gold mining companies can be profitable investments, they're typically more volatile and higher risk because there are more factors in play. What's the size of their reserves? What's the grade? Do the locations of their mines give country risk and do they hedge production?
GH: And like any other company, the quality of the management.
JE: Yes, another reason why investors tend to allocate gold miners to part of the equity component of their portfolio. The ‘bar or coin’ decision versus an ETF comes down to whether the investor places some value on the physical nature of gold, holding that wealth in their hands and storing an asset almost outside of the financial system. Some in the investment community want that and are happy to pay a premium. They sacrifice a bit of liquidity storing gold in a private vault or at home as it cannot be sold simply on an exchange or back to a bullion dealer. If the investor really wants exposure to the gold price in a portfolio, then typically they gravitate towards an ETF, especially if they're already buying shares. It’s easy to add to a portfolio alongside the rest of the shares or ETFs they own.
GH: When you say a gold bar comes with a premium, what are the costs involved?
JE: It’s the storage and insurance and security of taking care of physical gold. From the refinery’s or mint’s perspective, fabrication costs go into making a bar or a coin. The larger the bar, the premium as a percentage will be lower than buying a very small bar or coin. However, investors go into a pool when buying an ETF and the spread is lower. For example, $100,000 into a gold ETF might include a buy/sell spread of 10 to 20 basis points (0.1% to 0.2%) but if you put $100,000 into one-ounce coins or bars, the premium might be 1% to 1.75% for a cast bar or minted bar, or 4 to 5% for a coin to cover costs.
GH: You've been closely involved in the gold industry for many years, including when interest rates were higher than they are now. Some people criticise gold saying it's not an asset because it doesn't produce any income. Do you find this criticism of gold is less common now that many bonds don't produce much income?
JE: Yes but it’s not just the fact that there's no real income on bonds or term deposits. Gold is actually performing. If gold were falling in price, then earning nothing on a term deposit is better than earning negative on gold. And history backs this up the performance of gold in this interest rate environment. In the past, when real interest rates have been 2% or lower, gold has delivered about 20% per annum in nominal terms.
Why is that? One, the opportunity cost is low, but two, the reason interest rates are low is because the economy is struggling which over the cycle constrains company earnings. It makes sense that gold would outperform in this environment. And three, we should factor in the inflation argument. Interest rates could rise from here but if rates go up 1% and inflation goes up 2%, real rates have actually gone even lower.
GH: Do you think investors looking at an allocation into gold go through the same process as they might with other asset classes, such as 30% to Australian equities, 30% to global equities, 20% to bonds. So let’s do 10% to gold. Is it thought of as an asset in that way?
JE: Increasingly, we see that, especially as SMSF trustees, financial planners and institutions allocate to gold. It's a nuanced asset allocation conversation on the role that gold can play in a well-diversified portfolio. In the past, gold was more an ‘all-or-nothing’ thing. But it’s more sophisticated now and investors are asking about the pros and cons of this asset class. Many advisers now say 5% to 10% makes sense.
GH: As a permanent, long-term allocation, not only due to current conditions and low rates?
JE: My view is that every asset class has at least one negative attribute. There's no perfect asset class. In gold's case, the lack of income is less than ideal but it's always liquid and physical gold has zero credit risk. Its long-term returns stack up and it tends to outperform when rates are low or when equity markets are volatile. Those are the positives that make sense of an allocation.
GH: Are all gold ETFs essentially the same?
JE: It’s a big subject and maybe we can cover in more depth another time, but here are three things to watch. One, who is the issuer? Two, what is the management fee? As gold is a purely passive asset class and the ETF tracks the price, any fees cut into investor returns. And three, what is the liquidity of the product?
GH: I was surprised to read how much Perth Mint is part of the production process of gold in Australia and how much goes through your refinery - including all those tiny nuggets dug up by individual prospectors plus the massive production by major gold miners.
JE: Yes, but to be clear, we don’t mine directly, we have relationships with miners, and small prospectors usually go through a local aggregator. The vast majority of the gold we refine is sourced within Australia, which is the second or third largest gold miner in the world in terms of tonnage of production, currently in excess of 300 tonnes which is about 10% of world output. We do source from other countries but that’s typically gold mined by an ASX-listed company. Perth Mint is the largest refiner of newly-mined gold in the world and we process the vast majority of Australia’s production.
GH: What about the collectible coin market. Is that an investment?
JE: It’s a good business but a small component of the overall gold market. In the 2019 financial year, our total turnover was $18 billion and coins, medallions and minted products were about $1 billion of that. So about 5% of our market. Collectible coins are a subset of that $1 billion. There's the gold content and the gold value or silver value of those products so it's a niche market with other things such as theme, innovation and uniqueness driving that market rather than the precious metal price alone. So for the vast majority of investors that want gold in their portfolio, they will buy bars or an ETF.
GH: Where does silver fit in?
JE: Perth Mint is a major refiner of silver and we have depository accounts that allow people to buy silver and store it with us. We manufacture silver bars and silver coins. Most people's first interaction with precious metals is gold, as it has more ‘brand name’ recognition and everyone implicitly knows gold is valuable. The role of gold in a portfolio is clearer, such as the correlation with equity markets and ‘risk off’ investing. Large investors who want to invest in precious metals will tend to stick to gold.
GH: Flows into gold ETFs have been strong in the last year. Besides the simple reason that the price is rising, how much comes from the currency debasement argument, massive amounts of government debt undermining ‘fiat’ currencies?
JE: To give some context, in the first six months of 2020, about 700 tonnes of gold went into gold ETFs globally. That was more than in any previous whole year. When you also consider the value of that gold, it’s about US$40 billion in six months into ETFs. The previous entire year was around US$22 billion, so the numbers are running at four times the previous record.
What does that tell us? The old school gold investor that is worried about fiat currency devaluation wants money out of the financial system. They don't buy ETFs, they buy physical gold. The gold ETF flows represent a huge number of new entrants into the gold market that want the price and defensive exposure in their portfolio. In our listed product, PMGOLD, over the last 18 months, the number of investors on the registry has quintupled, including a lot of small holdings. I think the QE and now MMT story are part of the move to gold but it’s highly nuanced, especially when billions of government bond yields are negative. What are the safe havens when equity markets are expensive?
GH: When you said earlier that institutions tend to go ‘direct’, does that mean physical gold?
JE: Correct. Physical gold which they store with a custodian like The Perth Mint depository. In the last six to 12 months, we saw a lot more inquiries from regulated entities such as large super funds, and also family offices. It’s more cost efficient to go direct in large quantities. They only have one counterparty to deal with whereas an ETF will typically have four or more counterparties (the product issuer, the trustee, the gold custodian and the market makers). And they get legal title to the gold. With an ETF, you don't own the actual gold, you own a security that is backed by gold. With physical gold, it has a serial number that is assigned to the investor. Gold ETFs are popular because they've made gold more cost effective for retail investors.
GH: So if a large institutional puts $200 million into physical gold, do the gold bars sit in a vault in Perth with unique numbers on them that the buyer can inspect?
JE: Yes, we have the largest vaulting facilities in the southern hemisphere and after 120 years in business, we store about $7 billion worth of gold for clients ranging from central banks to sovereign wealth funds to mum and dad investors. Yes, absolutely, legal title to their own physical gold in a government-guaranteed vault. And yes, the investor can inspect the physical gold directly.
GH: Why is it government guaranteed?
JE: Perth Mint is owned by the Western Australian Government and it stands behind the liabilities that we have to depositors. Any investor in a Perth Mint product is protected by that.
GH: And what about SMSF demand?
JE: There's been incredible flows the last 12 to 18 months. COVID accelerated a trend that was already in place. It really started in Q4 2018 which saw a huge decline in equity markets on talk of Fed tightening and gold started to take off. Our ETF has quadrupled in size in the last two years.
GH: Last question. What could cause a bear market for gold?
JE: If the US dollar were to rise significantly, or if real interest rates were to rise, that might put downward pressure on gold. It would increase the opportunity cost of holding gold if investors could get 5% on US Treasuries and inflation stayed at 1%. And if we had genuine, rip-roaring bull market in equities due to corporate earnings and not just central bank liquidity, money might move out of gold.
Those are three factors that could drive gold lower. In reality, I expect low real yields for years to come, and equities are not cheap. The rationale behind investors wanting to own a hedge such as gold remains strong.
Graham Hand is Managing Editor of Firstlinks. Jordan Eliseo is Senior Investments Manager at The Perth Mint, a sponsor of Firstlinks. This article is general information and does not consider the circumstances of any investor.
For more articles and papers from The Perth Mint, click here.