The M&G Global Basics Fund does not hold any shares in gold production companies. This is because Fund Manager Graham French takes the view that gold companies are, on the whole, poorly managed by individuals who are more interested in status symbols and asset gathering than the efficient management of those assets.
The efficient use of assets is a pre-requisite for any investment made by the Fund. Graham French has a strong preference for companies that can deliver strong cash flows, something that gold companies have regularly failed to do. Indeed, historically, gold companies have delivered, on average, cash flow returns on investment of around 4% p.a., compared with the long-term average for all companies of some 6% p.a.
Currently, the share prices of some gold companies are implying long-term returns on capital of up to 20% p.a. Gold companies have never in their history delivered such returns, suggesting that these companies’ current prices may well be at unsustainable levels.
Another important issue for Graham French is the fact that the gold bullion price and the share prices of gold companies have ‘decoupled’ in recent years. This is in part because gold companies are not being run in the best interests of shareholders, but also a reflection of rising input costs due to the broad-based rally in commodity prices. Gold companies incur significant energy costs as well as the costs of replacement machinery. As these costs have risen sharply in recent years, gold companies’ margins have tended to lag behind the rise in the gold bullion price.
In the view of Graham French, platinum appears currently to be far more attractively valued than gold. Although the platinum price is testing new highs, the favourable supply/demand dynamic for platinum provides the Manager with reassurance that this price can rise further. On the supply side, there has not been a significant new discovery of platinum in the past 20 years, despite the rising platinum price having made the cost of exploration more financially viable. Platinum, however, remains strongly in demand for jewellery, and is also a key requirement in diesel auto catalysts and fuel cells, both of which are key growth areas.
