Small Cap Value Report (Wed 14 Aug 2019) - Negative interest rates & Gold, DUKE, LOOK, IND, EQLS, XSG

Wednesday, Aug 14 2019 by

Good morning,

There isn't a whole lot in the RNS today but we do have:

Negative Interest Rates

Since the RNS doesn't have too many stories which interest me, I thought I'd spend some time reflecting on the fact that 10-year fixed-rate mortgages are now being offered at negative interest rates in Denmark.

If you go to the source for this story, you'll find that there are disclaimers: due to set-up fees and other costs, the Danish bank which is offering this deal says that "you are not exactly going to make money borrowing".

Even so, this feels like an escalation of the "ZIRP/NIRP" phenomenon. It is almost certainly unprecedented.

(For context: the Danish krone is pegged to the euro and its official interest rate is -0.65%.)

Bank shares have achieved little for investors in recent years and when you read stories like this, it's not hard to understand why.

Until recently, many economists thought that negative interests rates weren't possible. Why bother giving money to someone, if they'll give you less back?

That logic is still quite sound, in my view! Low interest rate environments do have real effects on people's decisions. We are discouraged from saving and incentivised to spend the money on present-day consumption, instead.

But even with very low or negative interest rates, not everybody can consume all of their savings straight away. There are plenty of institutions and individuals who need to wait some period of time before consuming their savings, or who are forced to lend their money for some structural reason, and these are the ones forced to suffer negative interest rates.

Rediscovering Gold

These days, almost anything looks like a better investment than cash and bonds. Any real asset is inherently superior to paper assets.

But when you consider the negative interest rates and the unprecedented monetary conditions, there are strong reasons, at least in my mind, to focus on the prospects for gold. 

The reason for this is gold's historical basis as a currency and as a foundation of currency strength.

This means that when central banks have stopped debasing their currencies and…

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All my own views. I am not regulated by the FSA. No advice.

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59 Comments on this Article show/hide all

donald pond Wed 3:15pm 40 of 59

In reply to post #504546

Buffett is great at investing in certain types of companies, but he is hardly a rounded human. He has no interest in spending, so drives a rubbish car, eats burgers every day and lives in a modest house. There is an awful lot about business that he understands and a huge amount about human nature that he is clueless about. And gold always speaks to human nature.

You could just as well say anyone watching from Mars would be astonished that people use paper issued by governments that have no way of ever paying back their debts as a method of exchange. The US has already spent more in 2019 than its 2018 budget. The world is flooded with cheap money. Ray Dalio says that everyone should have 10% in gold at the end of the economic cycle. I think people are massively underinvested in gold and it has a long way to go. £AAZ is my preferred play too: great management, holding 40% of the equity, no debt, and, as Hardman said when the price of gold was $200 lower, "prodigiously cash generative"

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cmpeckham Wed 4:19pm 41 of 59

In reply to post #504671

1. You probably mean call options, not puts. A put option would not be exercised if the gold price rallies, a call would. Selling an out of money put option simply increases the exposure of your imaginary fund to gold (if the price of gold falls it loses twice). Selling a call option would make slightly more sense as this would replicate the strategy of "covered calls" equity funds.

2. Even if we change your strategy to selling calls, there is no theoretical advantage over simply holding gold. If there was an intrinsic advantage it would be arbitraged away. You might as well hold gold and sell 3% a year as a "dividend". You do get a different return profile (smoother) and a different return in different markets (depending on how volatile / up /down the market is) but no theoretical overall increase in return - hence just hold gold and sell some of your gains (or decreased capital) as income.

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spantick Wed 4:39pm 42 of 59

I have a large percentage of my portfolio currently in decent gold miners. So far with good returns, For some time now the likes of the Chinese, the Russians, major banks and institutions, the list goes on..... have been buying gold like there is no tomorrow and possibly for good reason. Where else could you put your money if the poo really hits the fan globally ?

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LongValue Wed 5:00pm 43 of 59

In reply to post #504726

The absurdity of negative interest rates, as well as the economic and political situation, have driven me into Gold more as insurance rather than an investment. It's there should events really go wrong. However, I have opted for a small portfolio of Gold mining stocks. All, bar one, are dividend payers and geographically dispersed. Gold explorers hold no interest for me. It's all about low-cost (Low All-In Sustaining Costs) and profitable production.

It might be worth mentioning that drilling a hole in the ground is fraught with problems from geology to environmental issues. It's an inherently risky business. And so I would not put all my eggs in one basket.

As Graham rightly points out, in recent years, Central Banks have been avid buyers of Gold. So let's take a step back. Central Banks have access to the most insightful information that the nation can provide. And the one asset they appear to be collectively stocking up on is Gold. Not Bitcoin but Gold. Hopefully, I am wrong but I get the impression that they are signalling that there is something rotten in the state of Denmark.

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sharmvr Wed 6:21pm 44 of 59

In reply to post #504721

Yep - I did mean calls, I realise after your post and realise that I shouldn't discuss or think about options!
Interestingly, option 2 is what I did with my holding (regretting now, but didn't know at the time) - I called it taking profits.

Thanks for the reply - helps me understand - as I say, if it was achievable, then I am sure blackrock would have an ETF for it!

Have a nice evening.

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Thornabian Wed 5:26pm 45 of 59

A company with exposure to gold (popularity) but not mining:

Augmentum Fintech invested in BullionVault which is an online platform for trading gold and other precious metals.

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Thornabian Wed 5:43pm 46 of 59

All this talk of how amazing gold stores value reminds me of a debate I had with an investment manager (at a company that will remain nameless) back around the end of 2011:

This investment manager was adamant gold was going to double again after a huge rally to somewhere above $1,200 (I dont remember the exact value) . He was so sure that he was telling them to put 30-40% in. I told him it is only worth what people view it to be and generates no cashflows.

I remember this so well because a few months after the discussion gold dropped around 30% - not sure what happened to his clients, I never did find out...

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cmpeckham Wed 7:18pm 47 of 59

In reply to post #504746

Blackrock may well be interested in implementing your covered call strategy. It would enable them to market a gold fund with yield. Funds with higher yields have high consumer appeal, even if they don't offer higher total return. Covered call equity funds sell very well.

If they don't do it now, it is probably because they can only make money on large funds and the gold option market probably isn't deep enough to support large funds.

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purpleski Wed 8:20pm 48 of 59

I would have to agree with bsharman on AAZ. I never expected to invest in a resource stock let alone an Azerbaijan based gold miner but this is my “the World is going to hell in a hand basket play” and stands at 20% of my portfolio and has worked out well since I first bought in October.

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homoyouni Wed 9:57pm 49 of 59

I am very bullish on precious metals at the moment for all the reasons mentioned above .

This is an interesting video regarding Gold and the Dollar worth checking out

I hold both physical gold and silver coins as well as interest in the following miners;
Caledonian mining – (which to date has been a poor investment due to the Zimbabwe economy ) , but aside from this my other gold and silver miners that are doing well and I believe have more upside include ;
Shanta gold,
Silvercorp metals,
Pan African resources,
and Trans Siberian gold.

Aside from that with the Brexit worries by investing in gold it provide one with some hedge against the devaluation of the pound that is happening – Just in the last month it dropped from 1.24 Swiss Francs to the £ ( which was low already ) to 1.174 to the £ at one point yesterday.

For reference in 2007 it was 2.47 Swiss Francs to £.

Also whilst Gold has increased in value in dollars terms by just under 17% in the last 3 months it has increased by over 25 % in pounds sterling reflecting the relative loss in value of the pound.

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jwebster Thu 4:34am 50 of 59

I also hold silver via a physically backed EFT. Reason being the Gold:Silver ratio is near its long term peak so I expect some mean reversion. Possibly silver will, over a year+ timeframe, rise more than gold.

Holding miners is interesting, especially the low debt AAZ discussed above, but I worry about black swan risks on individual companies, so prefer GDX.

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jwebster Thu 5:09am 51 of 59

Also, on Warren Buffett's point about gold has no value, other than human emotion.

Of course he's correct, it doesn't produce any cash flow, so using his DCF methodologies its value is nil. However, it depends on the next best alternative for your money. Deposits pay no interest either, potentially negative soon. WB keeps his horde in the bank in $USD. For all its woes, he has the might of the world's reserve currency behind him. At the moment, he's sitting on a huge pile, waiting.

For us, Sterling is NOT the world's reserve currency, far from it.

In general, as a safe haven for savings the main, highly liquid options are govt bonds, cash and gold.

Bonds likely will be ok if interest rates keep dropping, you will make a capital gain. But you have to have a view on inflation, if inflation arises your bonds won't do well.

Cash is the ultimate option if you are waiting to pounce on undervalued shares or London property :) Of course, cash is actually risky in a recession. If you have say £1 million cash in the bank, only £85k is covered by the govt protection scheme in the event of a bank failure. Deposit haircuts do happen, would a populist govt bail out 0.1% of wealthy depositors? Probably not in full.

That leaves gold and silver, which have the advantage of a relatively fixed supply and they hold value outside of general currency fluctuations and money supply increases. For me, the real hedge here is that I expect central banks to kick off a huge round of QE in the next downturn aka Modern Monetary Theory (MMT) and use it to fund big govt deficits. The last roll of the dice by our imprudent leaders. More money supply and higher deficits ultimately means paper currency devaluation against hard assets and the currency of any other country which has real resources and a current account surplus. The UK has neither, actually a large current account deficit, funded only by external investment flows, so Sterling has downside risk in such an environment.

Also gold is heavy traded so daily liquidity is good, if you need to raise cash and buy those bombed out stocks. I actually have a recession list, stocks like Rio Tinto, which seem to always crash in the cycle and then rebound on the recovery.

Hard to tell when all this will happen, could be a few years off, the bull market may have another leg left in it. Also Trump is banging on the Fed's door, he needs some stimulus to juice the US economy leading into his Nov 2020 election. And early next year he will 'solve' the trade war he created too, for the same reason.

But you have to position Gold/Silver before the herd arrives and it gets expensive, so I hold some now.

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timarr Thu 6:40am 52 of 59

In reply to post #504826

Of course he's correct, it doesn't produce any cash flow, so using his DCF methodologies its value is nil. 

Charlie Munger says he's never seen Buffett run a DCF analysis, ever. 

Mostly, of course, Buffett is correct - Gold is an unproductive asset. Where's it's really valuable, though, is where you live in a country with a high degree of political uncertainty, the potential for significant currency devaluation and the possibility of asset appropriation by a future government,

If you were unfortunate enough to live in such a country then having a stash of gold as a hedge against uncertainty would be very wise indeed.


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Thornabian Thu 7:30am 53 of 59

In reply to post #504831

Depends what price you buy the gold at. It's not a hedge to anything if it is overpriced. It holds some negative correlation to a weakening economic environment and high inflation but it isn't perfectly correlated and there isn't actually causation because their are other factors at play too simply because markets are completely global.

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Thornabian Thu 7:33am 54 of 59

In reply to post #504851

there are*

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JohnEustace Thu 7:38am 55 of 59

In reply to post #504576

I think you have that the wrong way round? The point of the GBP hedged version is to cancel out the GBPUSD currency movements. You need to buy the USD denominated units to get the full dollar exposure.

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herbie47 Thu 9:40am 56 of 59

Indigovision (LON:IND) I'm struggling to see why this is a superstock, QR is 87 but apart from a Piotroski score of 7, I can't see where the quality is, it hardly makes a profit, over the last 4 years it has made a loss.

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Nick Ray Thu 11:43am 57 of 59

In reply to post #504886

It looks like Indigovision (LON:IND) is being flattered by its F score and the "gross profits to assets" score in the Quality Rank. It has a good gross profit which gets completely wiped out every year and very few assets so gross profit/assets does well and the F score loses two points because Indigovision (LON:IND) does not actually make any profit but it is doing OK with the other tests (very little debt and it is losing less than it was!)

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herbie47 Thu 2:00pm 58 of 59

In reply to post #504956

OK thanks Nick, where are the gross profit figures? The operating profits are negative. Just surprising that a company that is loss making is a Superstock but I have seen similar ones before.

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Nick Ray Thu 2:17pm 59 of 59

In reply to post #505016

The gross profit figures are on the income statement under accounts. (Side-note: the operating profit does not seem to be gross profit minus expenses on IND's accounts.)

You can drill down into the quality rank for a stock by clicking on the quality rank value in any table it appears in (but not from the stock report.) (edit to add: does not work on new site.) You can drill down into the Piotroski F score by clicking on the link in the stock report.

But just to be clear I am not endorsing or passing any kind of judgement on the quality rating that Stocko is coming up with - just reporting how it got the number that it did.

I think a minor red flag is whenever the various components of the quality (or other) rank do not broadly agree with each other. When you compute an average but there are widely differing views of how much quality the stock has what does it mean? If all the various factors are roughly similar then clearly the average gives a smoothed view of the situation. But if (for sake of argument) I average 10 and 90 to get 50 that value of 50 is much less informative. It's clear there is more going on if the different valuations differ so much.

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About Graham Neary

Graham Neary

Full-time investor and independent analyst. Prior to this, I spent seven years in the financial markets as an analyst and institutional fund manager. I'm CFA-qualified, also holding the Investment Management Certificate and the STA Diploma in Technical Analysis.Away from finance, my main interests are recreational poker and everything to do with China, especially Mandarin Chinese. more »


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