'Defensive' is not always defensive

Gold mining shares are notoriously volatile. That is normal, because they depend on the price of the underlying metal, gold and silver, and input costs such as energy, labour and materials, which are volatile as well. As a group, gold mining shares, represented by the HUI-index, have a higher beta than the market average, meaning they rise and fall faster than the market on average.

But volatility, once again, is not the same thing as risky. Risk is the permanent loss of capital. An investment that is not volatile, i.e. a German government bond, may be extremely risky if exogenous factors such as interest rate hikes, hyperinflation and default destroy the principal investment.

To many investors, gold mining shares are very volatile, therefore they are risky. We believe this is a fallacy. In the current market environment, very few sectors of the economy are increasing margins, expanding production or increasing top line. Gold mining shares are completely discarded by the investor community. Most investors are not aware of the fact that fundamentals are improving by the day. To us, it is a miracle why gold mining shares have underperformed the underlying metal by such a wide margin over the past few months.

In the current market environment, many investors are positioned in what they perceive to be ‘defensive’ market segments, such as healthcare, telecoms, staples and utilities. To us, this is the wrong choice. Healthcare firms are struggling with patent expiries, telecoms and utilities revenues are low-hanging fruit for greedy governments, and staples are confronted with rising input costs.

In Belgium, discount retailer Colruyt, which has a great long-term track record and is commonly perceived as a defensive stock, saw its stock price plummet by 12% on Tuesday because the company reported disappointing earnings and rising costs.

So make no mistake, the only defensive options at the moment are cash, gold and gold mining shares. The latter are more volatile than the market average, but we are convinced that in the end they will prove to be less risky and will outperform mightily in a market setting that will be dominated by inflation, currency debasement and sovereign default risk.

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