A golden opportunity

For starters, there is now a very real chance that the European Central Bank (ECB) will embark on a fresh round of monetary stimulus to spark some much needed activity in the moribund eurozone economy in direct response to softening inflation expectations. ECB president Mario Draghi hinted as much last week.

That’s positive for gold, as is the fact that 10-year government bond yields have headed into negative territory in major eurozone sovereign states for the first time in the past week, including both France and Sweden. Ten-year German Bunds offer a 0.3 per cent negative yield. In fact, research from Bloomberg indicates that globally there is a record $12.5 trillion (£9.86 trillion) of negative-yielding bonds in issue. No fewer than 10 countries in the developed world have negative yielding sovereign bonds. Moreover, the average yield of the global bond market has collapsed from 2.51 per cent in November 2018 to 1.76 per cent today. This means that gold as an asset class has a very favourable pricing backdrop given that sovereign bonds are not only offering negative yields, but are eroding real value after accounting for inflation. This has not gone unnoticed; the gold price has just hit a six-year high of $1,406 an ounce and appears to be breaking out from a protracted multi-year holding formation.

It’s not just in Europe, either, that sovereign bond yields are falling. The US government 10-year bond yield has deflated from 3.24 per cent last November to 2 per cent today, a massive move that highlights a significant reappraisal by investors of both the country's domestic inflation outlook and economic activity expectations. Furthermore, although the US Federal Reserve held its Fed funds rate at last week’s meeting, the rate-setting committee noted that it would “act as appropriate to sustain [the country’s economic] expansion” and “closely monitor the implications of incoming information for the economic outlook”. The implication being that monetary stimulus is more likely in the future.

This is majorly positive for the gold price because a more dovish stance adopted by the US central bank will limit upside to the US dollar, and could indeed weaken it. Gold is priced in US dollars, so any softening of the greenback will be positive for the gold price. I would also flag up that central banks in Australia and India both moved to cut their benchmark rates earlier this month, too. India is an important source of retail gold demand.

The more benign interest rate environment means that the opportunity cost of holding a non-yielding asset like gold is negligible, thus tempting some investors to seek portfolio diversification in an investment climate where the major global central banks are expected to return to the printing presses. This is understandable given that the safe-haven asset acts as a hedge against a raft of potential scenarios that would drive demand for it higher. These include a damaging trade war between the US and China/and or Mexico; political instability in the Middle East that could ultimately lead to an oil price spike if supply routes through the Strait of Hormuz are restricted, thus accentuating the risk of a global economic downturn as a consequence, which in turn puts further pressure on central banks to ease their monetary policy; and potentially further sterling weakness in the event of a hard Brexit.

The final point is worth considering for UK investors given that the sterling gold price of £1,107 an ounce is only 6 per cent shy of the £1,178-an-ounce all-time high hit at the peak of the eurozone debt crisis in September 2011. The US dollar gold price of $1,406 an ounce is still 26.5 per cent off its high-water mark of $1,911 an ounce, the difference in their relative performance being accounted for by the devaluation of sterling against the greenback since the autumn of 2015.

Clearly, one way to play the potential for upside in the yellow metal is to simply buy an exchanged traded fund (ETF) that invests in gold, or even a geared ETF. However, another way is to seek out high-yielding shares in a company that offers exposure to a positive price environment for the precious metal. Diversified financial services group Ramsdens (RFX:183p), a constituent of my market-beating 2019 Bargain Shares Portfolio, and H&T both fit the bill. I covered Ramsdens' half-year results in a very positive light earlier this month, so will not dwell on that company.

H&T is also very interesting at this juncture, given that 35 per cent of the company’s gross profit of £88m in 2018 was derived from pawnbroking activities. The 9 per cent rise in the sterling value of gold since the company released its annual results in mid-March means that it will be able to offer higher loans to customers on gold and precious metal pledges. That’s clearly positive for profits from an activity that generates a risk-adjusted margin (as calculated by revenue earned on pledges less impairment as a percentage of average loan book) of 62 per cent. Also, in a rising gold price environment, the risk of H&T making a capital loss on its £52m pledge book, a chunk of which is made up of gold jewellery, is reduced in the event of a customer not settling their debt (around 83 per cent of customers actually redeem their pledges), and the pledged item having to be sold by the company. 

Furthermore, earnings from H&T’s gold purchasing and pawnbroking scrap activities – accounting for £5.2m of gross profit between them – are set to get a lift, too. That’s because a high percentage of incremental revenue earned (resulting from the sterling value of gold rising) on inventory sales will drop through to H&T's operating profit. H&T can also expect to make one-off gains on retail jewellery stock to reflect the higher value of the sterling price of gold.

There are positives in other areas of the business, too. For example, the company’s diversification into personal loans is clearly paying off. This activity produced a risk-adjusted margin of 38 per cent on its average loan book in 2018, and with a better risk profile of borrowers, too. That’s because 59 per cent of H&T’s year-end personal loan book of £20.5m was deemed non ‘high-cost-short-term’ credit.

The bottom line is that on a forward price/earnings (PE) ratio of 10, offering a prospective dividend yield of 3.5 per cent, and rated on a forecast year-end price-to-book value ratio of only 1.1 times, the potential for the gold price to continue to glisten is simply not being priced into H&T's current valuation. A return to the June 2018 high of 374p, and perhaps beyond, looks a very distinct possibility in my view. Buy.

■ Stock clearance offer. Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. 

Subject to stock availability, each book can be purchased at the promotional price of £9.95 per book plus £2.95 postage and packaging, or both books can be purchased for £19.90 plus postage and packaging of only £3.75. The books are being sold through no other source and are normally priced at £16.95 per book plus postage and packaging. A detailed outline of the content of each book can be viewed on YPDBooks website.