Sprott Gold Report: Gold Resilient Despite Market Volatility

Authored by Shree Kargutkar, Portfolio Manager, Sprott Asset Management LP

Volatility is Back

The calm of equity markets across the world was rudely interrupted in February by a sudden spike in volatility which impacted virtually every asset class. Volatility across equities, bonds, currencies and commodities rose sharply during the month and remained elevated into March. For the month of February, gold equities declined 10.10%, while gold bullion fell a modest 2.08%, as measured by GLD.2  The metal's lack of volatility merits further discussion which we touch on below.

Wake-Up Call for Markets?

Our perspective is that February’s events provided a wake-up call for markets signaling that the period of historically low volatility has come to an abrupt end. Over the course of the past 15 months, investors had grown accustomed to the lack of volatility in equity markets. The chart on the following page illustrates the realized volatility of the S&P 500 Index. Realized volatility (using a 90-day running average) in the S&P 500 has averaged 13.4% since 2011. The December 2017 low of 5.49 was one for the history books; to put this into context, equities were acting as benignly as the high-quality investment grade bonds.

Historical 90-Day Realized Volatility of the S&P 500 Index

Source: Bloomberg. Data as of 3/08/2018.

Since 2011, the widely followed CBOE VIX3 index has averaged 16.3. As central banks begin to reduce their balance sheet holdings and raise short-term interest rates, risk premiums across asset classes should normalize and so should volatility. At the time of this writing (March 8), the VIX sits at 16.9. Volatility has simply reverted to its mean, indicating that the environment of exceptionally low volatility is likely behind us.

Gold Bullion Was an Exception Amid Volatility

At Sprott, we have long been proponents of holding precious metal bullion and equities as a portfolio hedge against general market volatility. The events which transpired in February underscore the validity of our investment thesis. Volatility across many asset classes, including North American equities, global equities, Treasuries and currencies rose in February and remain elevated today. Gold bullion was a singular exception, given that its spot volatility as measured by the CBOE/COMEX Gold Volatility Index moved up by just under 3% from the beginning of 2018 to end the of February. By contrast, other asset classes experienced massive volatility increases of as much as 235% in the same time frame.

…While Gold Miners Declined

Precious metal equities were influenced by the general equity volatility and sold off in February, as was to be expected. However, the profitability of precious metals equities is predicated by bullion prices and with bullion prices firm and maintaining their uptrend there has been no change in the fundamentals of gold equities. In fact, we have pointed out in our previous commentaries that while gold bullion has continued to climb, the vast majority of precious metals equities have lagged the yellow metal. Indeed, gold equity valuations sit at depressed levels that we have not seen in our careers, and we posit that it is just a matter of time that these valuations normalize.

As market volatility rises, investor complacency is likely to fall. Investors will once again begin to pay closer attention to developments that are likely to impact the economy and markets, both positive and negative. We would argue that the weight of negative factors which can lead to further market declines over the medium term continues to rise. My colleague Trey Reik just published a Sprott Gold Report titled, Oopsie Daisy! Equity Markets Stumble in Early February. I strongly encourage clients to read this report as it summarizes the build-up of factors which are negative for both the equity and bond markets: Rising consumer stress, equity market pressure from higher interest rates, and last, but not least, the ballooning U.S. fiscal debt.

Favorable Tailwinds Support Gold Bullion

The declining U.S. dollar and rising inflationary pressures continue to provide favorable tailwinds for gold bullion. Gold’s relative lack of volatility has not gone unnoticed by investors. While large ETFs such as SPY and EFA4 have seen billions of dollars in outflows over the past several weeks, investment capital has begun flowing back into both gold bullion and equity ETFs. We would encourage others to look into the precious metals equities space. You would be surprised at how profitable some of these companies can be with gold prices above $1,250/oz.

1 SPDR Gold Shares (GLD) is an exchange-traded fund and is used as a benchmark to measure gold bullion prices.
2 VanEck Vectors Gold Miners ETF (GDX) tracks the overall performance of companies involved in the gold mining industry.
3 The U.S. Dollar Index (USDX, DXY) is an index of the value of the U.S. dollar relative to a basket of foreign currencies.
4 XAU is an index of precious metal mining company stocks that are traded on the Philadelphia Stock Exchange.

The information contained herein does not constitute an offer or solicitation by anyone in any jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation.

Forward-Looking Statement

This report contains forward-looking statements which reflect the current expectations of management regarding future growth, results of operations, performance and business prospects and opportunities. Wherever possible, words such as “may”, “would”, “could”, “will”, “anticipate”, “believe”, “plan”, “expect”, “intend”, “estimate”, and similar expressions have been used to identify these forward-looking statements. These statements reflect management’s current beliefs with respect to future events and are based on information currently available to management. Forward-looking statements involve significant known and unknown risks, uncertainties and assumptions. Many factors could cause actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results, performance or achievements could vary materially from those expressed or implied by the forward-looking statements contained in this document. These factors should be considered carefully and undue reliance should not be placed on these forward-looking statements. Although the forward-looking statements contained in this document are based upon what management currently believes to be reasonable assumptions, there is no assurance that actual results, performance or achievements will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this presentation and Sprott does not assume any obligation to update or revise.

Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any fund or account managed by Sprott. Any reference to a particular company is for illustrative purposes only and should not to be considered as investment advice or a recommendation to buy or sell nor should it be considered as an indication of how the portfolio of any fund or account managed by Sprott will be invested.

Past performance does not guarantee future results. The views and opinions expressed herein are those of the author’s as of the date of this commentary, and are subject to change without notice. This information is for information purposes only and is not intended to be an offer or solicitation for the sale of any financial product or service or a recommendation or determination by Sprott Global Resource Investments Ltd. that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on the objectives of the investor, financial situation, investment horizon, and their particular needs. This information is not intended to provide financial, tax, legal, accounting or other professional advice since such advice always requires consideration of individual circumstances. The products discussed herein are not insured by the FDIC or any other governmental agency, are subject to risks, including a possible loss of the principal amount invested.

Generally, natural resources investments are more volatile on a daily basis and have higher headline risk than other sectors as they tend to be more sensitive to economic data, political and regulatory events as well as underlying commodity prices. Natural resource investments are influenced by the price of underlying commodities like oil, gas, metals, coal, etc.; several of which trade on various exchanges and have price fluctuations based on short-term dynamics partly driven by demand/supply and also by investment flows. Natural resource investments tend to react more sensitively to global events and economic data than other sectors, whether it is a natural disaster like an earthquake, political upheaval in the Middle East or release of employment data in the U.S. Low priced securities can be very risky and may result in the loss of part or all of your investment. Because of significant volatility, large dealer spreads and very limited market liquidity, typically you will not be able to sell a low priced security immediately back to the dealer at the same price it sold the stock to you. In some cases, the stock may fall quickly in value. Investing in foreign markets may entail greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks. You should carefully consider whether trading in low priced and international securities is suitable for you in light of your circumstances and financial resources. Past performance is no guarantee of future returns. Sprott Global, entities that it controls, family,


Shree Kargutkar
Shree Kargutkar
Portfolio Manager
Sprott Asset Management LP

Sprott Asset Management LP is the sub-advisor for Sprott Gold and Precious Minerals Fund and Sprott Silver Equities Class.
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