One of the market sectors I used to cover was mining. Lacking a crystal ball – and having little faith in my or anybody else’s ability to forecast future commodity prices – I needed to look for other angles and themes within the sector.
One disparity I noticed was the relative rating of large-diversified miners, such as BHP and Rio Tinto, versus gold and silver miners, like Randgold and Fresnillo.
The diversified miners consistently traded on a lower P/E ratio than the precious metal ones.
The inference was a $1m profit from mining copper or iron ore was worth less than a $1m profit from mining gold or silver. Either the stock market was always more bullish about the outlook for the gold price than the copper one, or gold mines were deemed to be less risky.
Examining brokers’ discounted cash flow (DCF) valuations and price targets was a real eye opener. For the diversified miners the discount rate used was typically 8%, and the price target was 0.7-1.2 times the DCF value. As hard as I tried, I couldn’t convince the analysts that their price target should simply be x1.0 their DCF valuation.
However, it was the gold mining sub sector where common sense had really left town. Firstly, the discount rate typically used was 0-5%, then the price target was 1.5-2.0 times the DCF valuation. The combination of bullish gold price forecasts and a low discount rate produced a high DCF valuation. Then multiplying this by two gave a stratospheric price target.
The gold miners normally traded below these insane price targets but were still on much higher ratings than the diversified ones. When I asked the gold mining analysts to explain why they were using such low discount rates, I was told this was how they were valued in Vancouver, or gold was a “risk off” asset.
At the time the largest gold mining stock quoted in London was Randgold Resources.
All its production was in three African countries: Mali, which was invaded by Al-Qaeda backed groups in 2012; Ivory Coast, which had a civil war in 2011; and the DRC, which has had multiple armed conflicts over the last 25 years. Hardly a risk-free environment in which to operate.
The final nail in the coffin was the gold price.
Unlike other commodities, it tends to trade at a premium to its marginal cost of production. This premium is caused by investors, rather than just industrial users, buying it as insurance against the end of the world. To me, it looks like expensive insurance that may never pay out.
This unattractive combination of a high gold price, over optimistic DCF valuations, idiotic price targets, high P/E ratios and low, implied future returns meant I never owned a single gold mining share in over 30 years. I left the gold sub sector to the goldbugs, who I viewed as lunatic fringe, conspiracy theorists.
Jump forward a few years and these goldbugs suddenly look like conservative investors.
While the world gold council talk about taking a 200-year view, two new fads – cryptocurrencies and Non-Fungible Tokens (NFTs) – have attracted the attention of the get-rich-quick crowd and conspiracists.
Some bitcoin supporters describe it as ‘digital gold’. I’ve described it as worthless monopoly money, while Warren Buffett likened it to ‘rat poison squared’. In my view, NFTs are just as bad.
NFTs are digital files that live on a blockchain and verify ownership of a piece of digital art. Buyers typically get limited rights to display the digital artwork they represent, but don’t own the copyright. The digital artwork can be reproduced by third parties.
So, the NFT owner just has bragging rights and a token that they can resell later. Anybody can create and sell an NFT. You just ‘mint’ a piece of digital art, paying an administration ‘gas’ fee in a crypto currency. Like cryptocurrencies, NFTs are unregulated.
In March 2021, in an auction at Christies, Beeple sold an NFT for his digital artwork ‘Everydays: The First 5000 Days’ for $69m. This surprising news, kick starting interest in NFTs as a potential asset, and for some people validated their worth.
Not for me.
The buyer was reported to be Vignesh Sundaresan, the founder of the Metapurse NFT project. Some sceptics speculated that his goal was to drive up the price of his own NFT collection.
What if I sold a painting to myself at an inflated price? The high ‘valuation’ is reported, and later I could attempt to sell it on at a discount to a third party, who may erroneously think that they have got a bargain.
This is analogous to a food retailer listing a £3 wine for £10, and a few weeks later offering it at half price for £5. The wine buyers are tricked, but at least they end up with a £3 bottle of wine.
Last week GameStop shot up when it was reported that the loss-making videogame retailer was planning to launch a division to develop a marketplace for NFTs and also establish cryptocurrency partnerships.
GameStop are trying to sell picks and shovels in a gold rush, but a meme stock, NFTs and cryptocurrencies sounds like rat poison cubed to me.
The Secret Pension Fund Manager is a former institutional equities investor with more than 30 years’ experience. For more from the Secret Pension Fund Manager, click here.
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