Gold doldrums propel Moneyball tactic from ETF seeking edge
July 23 2017 09:45 PM
After gold surged through the first five months of 2017, investors are souring on the metal and mining ETFs as Federal Reserve officials signal their willingness to tighten monetary policy

Bloomberg/New York

Frank Holmes is no Billy Beane, but he’s trying to replicate in an exchange-traded fund what the baseball manager did with an underdog team in the movie Moneyball.
In the 2011 film based on Michael Lewis’s book, Beane of the Oakland Athletics used quantitative analysis to find underrated players, with a budget that was just a fraction of bigger-market franchises such as the New York Yankees. Beane’s team went on to post a record 20-game winning streak in 2002. 
Holmes, chief executive officer of US Global Investors, is hoping to do something similar with his firm’s newly-launched ETF to lure investors into gold equities at a time when money is exiting in droves.
After gold surged through the first five months of 2017, investors are souring on the metal and mining ETFs as Federal Reserve officials signal their willingness to tighten monetary policy. 
The retreat in bullion was highlighted by a record $3.2bn outflow last quarter from VanEck Vectors Gold Miners ETF, the largest such fund linked to producers. With mining equities trailing the broader market, fund managers are considering the unconventional to stand out.
“There’s a harder case to be made today than a quarter or two ago” in bringing in new investors into gold-mining equities, Matthew Korn, an analyst at Barclays in New York, said in a telephone interview. “I hear that, I see that among my clients. There’s this sense that you have a Fed that’s operating fairly hawkishly. If that’s kind of the prevailing view, it’s harder to want to go and buy gold stocks.”
Attracting new money into gold assets has been a big challenge after investors have been burned by the gyrations in bullion prices. 
In the decade-long bull-run that took prices of the precious metal to a record in 2011, companies including Barrick Gold Corp, the world’s largest producer, rushed to ramp up output to meet rising demand for the metal, accumulating debt as they expanded. 
As prices reversed and the metal languished in a bear market for years, investors hit the exit, leaving many miners unable to service their obligations and forcing them to cut cost to survive.
San Antonio-based Holmes thinks he’s found the secret sauce in streaming and royalty companies, which help finance miners in exchange for the right to buy the mined metal at a discount in the future. 
Because they’re not directly involved in digging, they tend to generate more cash flow and higher revenue per employee during market slumps, he said. They also carry less risks compared with mining firms that operate in politically unstable or geographically remote regions.
About 30% of Holmes’s US Global GO GOLD and Precious Metal Miners ETF, which trades under the ticker GOAU, is allocated to streaming companies Royal Gold, Franco-Nevada Corp and Vancouver-based Wheaton Precious Metals Corp Historical data provided by US Global on the index they developed for their newly launched ETF show the gauge over the past decade outperforming those used by its two biggest rivals, managed by VanEck Vectors.
“They have to make the beauty contest,” Holmes said in an interview at Bloomberg’s headquarters in New York, referring to the selection process for his ETF. “It’s really, really simple in the respect that it has factors that give you higher probability” that the stocks will outperform their peers, he said.
VanEck didn’t respond to a request for interview through its spokesman Chris Sullivan with MacMillan Communications.
Even so, the success of the strategy may still depend on the outlook for gold. Money managers who are bullish on the metal often shy away from streaming operations, betting they can capture more value in mining companies that directly benefit from a rally. Sprott Gold Miners ETF, whose picks are also based on a quantitative model, exited Franco-Nevada and Wheaton Precious Metals in May 2016.
“Sometimes, the streamers and the royalty companies can trade at excessive cash flow valuations,” Peter Grosskopf, the Toronto-based chief executive officer of Sprott, who’s bullish on the precious metal, said in an interview at Bloomberg in New York. “We think there’s better value on the ground with the producers, so we have to react to that.”
After more than doubling since the end of 2015, Denver-based Royal Gold is now trading at about 203 times free cash flow, the most of the members of the S&P/TSX Global Gold Index, according to data compiled by Bloomberg. Franco-Nevada is at 84 times free cash flow. That compares with 21 times for Randgold Resources, the largest holding in the Sprott ETF.
Streaming companies typically carry a premium over the miners because of their lower operating risk, said Dan Denbow a portfolio manager at the $600mn USAA Precious Metals & Minerals Fund in San Antonio, which owns Royal Gold and Wheaton.
“Their business model is very good,” Denbow said in a telephone interview. “But their revenues are just as tied to commodity prices. You’re giving up some upside when prices are rising. You’re also giving up some of the operating leverage downside.”

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