Gold is a golden opportunity once again -L1 Capital on how to play it

The gold price has begun moving again in recent weeks, and its suggestive of a new phase in the gold trade, says Raphael Lamm, Co-Founder of L1 Capital. 

We spoke to Lamm on where he's currently seeing the opportunities in gold and gold equities. He also explains the key developments behind their thesis from the proposed acquisition of Ausgold by OceanaGold, alongside recent developments across gold and US Treasury markets.

Against that backdrop, Rafi shared his thoughts on why L1 remain constructive on gold, why  the opportunity in selected gold equities is particularly compelling, and importantly, why we don't need a materially higher gold price to generate attractive returns from the companies we're investing in.

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Why L1 is constructive on gold

Following the recent reset in the gold price, we believe the macroeconomic backdrop remains highly supportive for gold.

Gold has experienced significant volatility this year, but we believe much of the speculative positioning has now been cleared from the market. This allows the longer-term, more structural drivers of gold demand to come back into focus.

One of the most important of these is continued central bank accumulation. Central bank net gold purchases rebounded sharply in Q2 to 289 tonnes — more than five times Q1 levels and a record for a second quarter.

China remains an important buyer, while central banks across a range of emerging markets continue to accumulate gold. Despite the significant buying already undertaken, we believe this structural reallocation has considerably further to run, particularly given the relatively low allocation to gold among the reserves of countries such as China and India compared with a number of major Western economies.

The US fiscal backdrop is becoming increasingly important

Another important part of our gold thesis is what is happening in US bond markets.

Long-dated US Treasury yields remain elevated at a time when the US faces an increasingly challenging fiscal position, with very high levels of government debt, growing interest costs and continued large-scale debt issuance.

In our view, these conditions highlight an increasingly difficult tension between maintaining confidence in the US dollar and keeping long-term borrowing costs at manageable levels.

We believe this backdrop is fundamentally supportive for gold over the longer term, particularly as investors and central banks consider the role of gold as a store of value and portfolio diversifier.

Why you don't need a higher gold price to make money

While we remain constructive on gold itself, one of the most interesting aspects of the current opportunity is that we don't believe gold prices need to move materially higher for us to generate attractive returns from selected gold equities.

Across our portfolio, the implied or "need-to-believe" gold prices embedded in the valuations of a number of companies remain well below the current spot price.

This creates the potential to generate attractive returns through bottom-up stock selection even in an environment where the gold price simply remains around current levels.

We are currently seeing opportunities across mid-cap producers as well as an expanding group of attractive late-stage, single-asset developers. In our view, valuations remain compelling and, even allowing for cost inflation, current gold prices have the potential to drive further improvement in cash margins across the sector.

This is where our bottom-up approach becomes particularly important. Rather than simply taking a directional view on the gold price, we are looking for individual companies where we believe there is a significant disconnect between the underlying value of the asset and what is currently reflected in the share price.

Ausgold: a very recent example of the opportunity

This week's proposed acquisition of Ausgold (ASX: AUC) by OceanaGold provides a timely example of the type of opportunity we are looking for.

L1 initially accumulated a position in Ausgold at around $0.50 per share. A little over a year later, OceanaGold has proposed acquiring the company in a transaction that implies a value of $1.36 per Ausgold share.

Our original thesis was that Ausgold was under-owned and under-appreciated, particularly by the Australian market. The proposed transaction provides a recent example of that value being recognised, and we believe there are other opportunities across the precious metals sector displaying similar characteristics.

For us, that combination — a supportive structural backdrop for gold, attractive valuations within gold equities, and the ability to identify company-specific opportunities through deep, bottom-up research — makes this a particularly interesting time for the sector and for L1 Gold Fund Limited.