Goldbug John Hathaway finally sees light at the end of the tunnel
The mining specialist lost ground when Covid pushed investors to safe havens but he’s keeping faith in his mid- to small-cap bias. But, he believes a recovery is due.
by VICTOIRE BARBIN PERRON - citywireselector.com
John Hathaway has experienced a lot of change in his 50 years of gold investing. In 2020 alone, he has seen his long-running fund absorbed by a new company and then witnessed the onset of a global pandemic.
Hathaway co-runs the Tocqueville Gold and Sprott-Falcon Gold Equity strategies with Doug Groh. The managers’ funds were taken over by Sprott Asset Management at the start of the year, when the duo moved across to their new employer.
While the world around them has shifted dramatically, their approach hasn’t and its emphasis on small- and mid-cap equities has recently come under pressure even as gold claimed the spotlight amid growing investor panic and a flight to safety.
However, while physical gold was finding favour, mining companies and related stocks struggled. Hathaway is confident this ‘under-owned’ sector will come into its own over the next five years, but he is aware of the challenges in the short term.
‘Investors need to understand that mining does not come without risk, as opposed to physical gold, which has very little risk, one can always sell the metal with a very narrow spread. But mining has to account for a multitude of components, including location, political jurisdiction, and geology,’ he says.
Hathaway, who has not held a Citywire rating since February 2017, believes his long-term investment style and preference for mid- to small caps will pay off in the next couple years despite recent underperformance and related outflows.
Hathaway has lagged his average peer on a one- and three-year basis, having returned 44.7% over the 12 months to September 2020 and 46% over the longer time frame. This is while the average manager in the Equity – Gold & Precious Metals sector returned 53.4% and 61.7%, respectively.
This drop in performance was coupled with outflows from his funds, with around $500m (€424.8m) pulled from the Sprott- Falcon Gold Equity fund over the year to the end of September 2020, according to Morningstar. The fund now has $71.4m in assets, albeit with minor positive inflows in September.
However, Hathaway is undeterred and plans to stick to his guns when it comes to unearthing smaller-scale opportunities. ‘A lot of the small caps we favour probably performed worse than more liquid names that were part of passive strategies, such as the GDX ETF,’ he says.
‘Our long-term style and skew towards mid and small-caps may explain our underperformance. When we have performed well, it is because that bias really worked,’ he adds.
BIGGER SLICE OF SMALLER PLAYERS
Hathaway’s active gold mining strategies, which comprise both Ucits-compliant sub-advised funds and non-Ucits ones, are composed of about 20% large caps and 80% small to mid-caps. The Sprott-Falcon Gold Equity Ucits fund had 26 positions at the end of August 2020.
For context, the aforementioned GDX ETF – VanEck’s giant gold ETF – is more concentrated, with its top 10 positions accounting for 60% of its assets under management. Where Hathaway hopes to gain an edge is through only having 30% of his investments tied up here.
‘In the small- and mid-cap space, value can be added more dramatically from successful drilling, or the construction of a new mine. These drive up the value in addition to the gold price moving in the right direction,’ he says.
Hathaway adds that small companies such as Torex Gold Resources (a 3.9% position as at the end of August 2020) or MAG Silver (5.56%), which he holds in his portfolios, doubled their value independently of the gold price. ‘The margins in gold production can rise even more than gold price rises. Therefore, the appreciation from mining stocks should be greater than owning the physical metal,’ he adds.
Hathaway reiterates the need for long-term patience in the sector and argues strongly against the idea that he should adopt a more cut-and-thrust approach, akin to some hedge funds that move into the natural resources sector.
‘We are very long-term investors; we do not have high turnover. We have an idea about what a company can achieve but those things don’t happen overnight. It is not about being agile enough to trade out of liquid names, but rather recognising companies’ long-term potential.
‘When this next leg in the gold market picks up steam, we will outperform and our skew will look relatively good.’
While the pandemic has taken a toll on industries across asset classes, Hathaway is confident that gold mining remains a strong long-term opportunity, unlike other parts of the investment world that have seen their business models severely challenged by the virus.
Hathaway highlights how mining companies compare with airlines in this respect. He expects many travellers to avoid airports for a long time but says gold will continue to prove attractive and this will underpin the investment case for miners and mining stocks.
He adds that a lot of these stocks do not carry the same levels of debt as many leisure or aviation stocks, which makes them nimble and resilient in comparison. ‘Gold mines are healthy on a three-year view, healthier than anything in the S&P 500, apart from Amazon,’ Hathaway says.
Here Hathaway makes the case for buying mining stocks as well as gold itself to get the best of both worlds. ‘There are pros and cons to both physical gold and gold mining exposures – it depends on the investor’s risk profile,’ he says.
While Hathaway is adapting to his new surroundings with Sprott – which is based in Canada and runs $17bn in assets – he has also noticed a significant change in the industry: the push towards ESG. He says miners have taken big strides towards improving education around these issues.
In September this year, Hathaway co-wrote an open letter to the mining industry, supported by 24 signatories, including managers from Invesco, Franklin Templeton and VanEck Funds, which called on gold miners to raise awareness and help companies better align with ESG considerations by combining the interests of fund managers, shareholders and boards.
Hathaway said ESG-conscious firms equate to better-run businesses. ‘Quality mining companies know it is good business to have positive relations with the community. You cannot finance a mine today without environmental compliance, as well as social and governance aspects,’ he says.
While larger companies are tackling all aspects of ESG, smaller ones can struggle to meet governance guidelines, specifically. But Hathaway is pushing for small caps to join the ESG wave.
‘Smaller companies shouldn’t have too many board members, for instance. What you want is the best possible board composition. Some of the firms we hold listen to us, especially when we have large positions. The ideal board size is maybe five to seven members at most,’ he says.
Dr. Nisha Long, head of cross-border investment research
Has the manager encountered these problems before?
Hathaway’s performance in the Equity – Gold & Precious Metals sector has been sporadic over the last decade. The worst period came in 2011 to 2015 and in each of these discrete five years he produced negative returns. However, on many occasions he has clawed back returns after bad quarters. The fund has a bias to miners, and recent Covid-related challenges have exacerbated the downturn in mining stocks. This has hit Hathaway’s funds hard and his faith in small and mid-cap stocks adds to the risk as these bets tend to take time to play out.
Can the manager turn it around?
Hathaway’s performance this year shows he can recover. Despite losing 24.5% in the Equity – Gold & Precious Metals sector in Q1 this year, he rebounded strongly with performance up 58.5% in Q2 followed by 9.2% in Q3. The year could end in positive returns if this trajectory continues. Hathaway delivered a 36.6% return in the sector last year, which also bodes well. Gold mining stocks stand to benefit from the rush to physical gold in this uncertain economic environment, and historically these stocks have gained a boost from rising gold prices.
However, investors need to bear in mind that this is a long-term strategy and Hathaway’s strong bias towards small and mid-cap mining stocks is not for the faint-hearted. That said, if held for the long haul these companies can produce healthy returns especially with the manager’s renewed focus on ESG integration. His funds do have a high risk profile and this is likely to combine with volatile returns. But it’s worth noting that gold mining stocks have been able to deliver three times the returns of physical gold in past cycles.
This article was originally published in the November edition of Citywire Selector magazine.