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Ask The Expert - Ned Naylor-Leyland - December 2015

Ask The Expert - Ned Naylor-Leyland - December 2015
By Craig Hemke - TFMetalsReport.com 3 years ago 3962 Views

Our new interviewer, Craig Hemke began his career in financial services in 1990 but retired in 2008 to focus on family and entrepreneurial opportunities. Since 2010, he has been the editor and publisher of the TF Metals Report found at TFMetalsReport.com, an online community for precious metal investors.

December 21, 2015

Ned graduated with a BA (Hons) degree from the University of Bristol in 1998. He began his career in 2001 at Neilson Management, later moving to Smith & Williamson (formerly NCL Investments) in 2003 where he was an Investment Manager. Ned joined Cheviot in July 2008 and is Advising a specialist Precious Metals fund.


Craig Hemke: Well, hello everyone and welcome to the December edition of Ask The Expert here on Sprott Money News. I'm your host, Craig Hemke, and joining us today is Ned Naylor-Leyland. Ned is a portfolio manager with Old Mutual Wealth in London and it's a pleasure to have him on the program. Ned, thanks for taking some time with us here at Sprott Money News.

Ned Naylor-Leyland: Thanks, Craig. It's good to be here.

Craig Hemke: Listen, my friend, for folks out there that don't know you or aren't familiar with your work, could you please just take a second and let everybody know who you are, what you do for a living and who you work for?

Ned Naylor-Leyland: Sure, of course. So as you say, I work for Old Mutual Wealth as a portfolio manager, looking into setting up a new product at the moment, actually, in precious metals, it's a sector I've been investing in since 2001 in various different forms. Of course, we know each other from having spoken before. I'm always cautious about the idea of being an expert but I suppose I've been investing in this space for a while so I have some level of insight.

Craig Hemke: And it's been an interesting last couple of years, but after all we've seen, perhaps maybe we're due for a turnaround. I know when word got out that you were going to be a guest here on Ask The Expert, we had a number of questions get emailed in, so if you're ready, I'll start laying them on you.

Ned Naylor-Leyland: Absolutely, go for it.

Craig Hemke: All right. Question number one, with the Fed raising interest rates this week and promising even more rate hikes in 2016, how do you see this impacting gold and silver prices in the days ahead?

Ned Naylor-Leyland: That's obviously a difficult one. I think that, first of all, the market has been waiting for so long for a hike that I think this time around truly, the Fed was painted into a corner, it had no option but to do something I don't think they actually particularly wanted to do, and so far it looks to me like it probably will create a bit more dollar strength. Now, were that to be the case, I think for you guys in the U.S., certainly, it's not so much in Canada, but in the U.S., where you are, I think that's not such a good thing.

I think of it in a slightly different way, being based out of Europe where gold prices are in euros or sterling, whichever currency you're denominating your portfolio in. But how do I think it will affect the...let's say, let's look at it as the dollar-gold price and what do I think it will do. I think the...I think we're ready for a turnaround absent an equity market lurch lower, I think if that happens, then I think there's every chance you could see something similar to the last major crisis where initially, you get a liquidation, just mainly due to hot money flows and then I think we'll be off higher at that point. I think either way, what we've been suffering from is this non-stop, drip-drip promise of interest rate hikes for three and a half years and the failure to deliver on that has been punishing, because the bond market and currency markets have been presuming high yields for that long and it's been affecting our sector.

So look, it's not really a very clear answer, but I think that either we're ready for a turnaround or we could see this hike create some problems in the equity markets, probably, first of all, via the high-yield bond market, but what I mean is I think people's focus is really on the S&P and the FTSE and so on. And that would be how I would answer that question.

Craig Hemke: All right. The second question, it dovetails right into what you were just mentioning, this idea of the strength in the U.S. dollar. And so, the actual question is: the rising U.S. dollar has already led to numerous currency devaluations around the globe. What would be the impact if this trend continues in 2016?

Ned Naylor-Leyland: Well, I think it will be very, very painful. I think we're already seeing that this is an unsustainable situation due to the amount of dollars being carried globally at the corporate level. Paul Mylchreest, who I think you know as well, he writes very lucidly on this subject and he's been pointing out for a long time that there's a shortage of euro-dollar collateral in the banking system outside of the U.S., and I think that hiking rates and restricting the dollar environment is very problematic for the global banking system, it's the unspoken issue of the dollar.

There are more obvious components to a rising dollar that one might consider as well, but I think that's the big one. And I think that if we break the high, or the recent high in the DXY, not that it's a particular interesting basket but everyone looks at it and I think it will tend to become self-fulfilling, I think it will go quite a lot higher than where it is now and I think that will be very disruptive.

You only have to look at the difference, I think you and I were discussing last week, separate to this interview, or maybe I sent you something, showing the difference between the trade-weighted price of gold over 40 years and the dollar price of gold and you can see that both in terms of your question about dollars and emerging markets, but also through the way it's interwoven with the gold price, that what you've seen in the last 12 months is completely anomalous. It doesn't normally happen like this and I think it's a sign of a genuine problem in the money system, which is the ending of this current reserve currency system and the evolution to a new one.

But yeah, I think a lot higher for the dollar has to be a problem for everybody. I don't see how that benefits anything in the current system.

Craig Hemke: Let me throw in my own question as a follow-up to that, Ned. In your work as a portfolio manager, primarily looking at mining shares around the globe, do you try to factor what you anticipate in terms of currency wars and currency devaluations and how that might impact underlying commodity prices?

Ned Naylor-Leyland: That's an interesting question, because previously, no, not really. But yes in the last 12 months and going forwards, yes. And I think, again, if you think about the divergence in that chart that I referred to, that speaks to this. Yes, one's been forced...we certainly quite early on in this trend, switched our attention to primarily Canadian and Australian mid-cap producers in our mining share basket, which of course have benefited materially versus their U.S. peers from the state of the currency markets. There's no doubt that's been a real driver and particularly for the Aussies.

So yes we do and I think now we're...particularly when the spot price isn't going in your favor, therefore the operational margin of the company have become very, very important to their ability to sustain a rising share price. And in that environment, yes, I think we are forced to do it, we do do it and it's absolutely a core part of the investment process.

Craig Hemke: Okay. Well, question number three, then, gets to something that I'm sure is near and dear to the subject or to the hearts of everybody listening, that is this ongoing downtrend, we've had a three-year bear market in precious metals prices and we're trying to search for some type of bottom, obviously. So in your view, what are the key trends to watch for in 2016 as we hope for a price turnaround?

Ned Naylor-Leyland: Trends to look for for a price turnaround...look, I think that you and I both know that because of what we've been through, what we need is a meaningful rally and what I mean by that is not $150 an ounce. That doesn't mean to say that you can't trade those kinds of moves and you can't benefit from it. But I think to get a sustained momentum change, we need either something...a loss of confidence in the spoon vendors or central bankers, as they like to be called. You need a loss of confidence in them, you need a general sense of confusion and concern about the monetary system, which has gone away despite the fact that it's clearly there and there are very big problems in the underlying architecture. I think that those things are, I'm afraid, are necessary for a rising price.

However, one thing I'd be looking at, and I spoke at Mines and Money a couple weeks ago, I really only came across this technical point because I was researching, doing work for my presentation, but I think there's something which I'm looking at which is quite exciting, which is the...the MACD, the particular MACD which again, Paul Mylchreest favors to look at long-term trends in the equity market. I applied it to the gold-silver ratio and it, amazingly, it's actually crossed already. Now if you look at this MACD over 15, 20 years, it's very, very good at leading you in and out at more or less, more or less, at the top and the bottom of trends. And it has actually crossed the gold-silver ratio, in other words, it's indicating the gold-silver ratio's going to fall.

Now, my two observations further to that, I would say, first of all, I'd like to see it for at least another month or maybe even two months confirming that MACD cross. Were that to happen, I would start to get quite excited, because it's, to me, those types of dispassionate technical signals are the more interesting ones and the consistency of this particular indicator in, as I say, leading you in and out of markets over long time frames is very, very good. Surprisingly so.

So the first observation is, let's see it confirm itself. It's already there but we'd like to see it confirm. The second observation is if that's going lower, it's only going to be in a condition where both metals are going up. That's it, full stop. Therefore, for me, that right now is...it's got my attention and I'm watching it like a hawk and I'm very interested to see where we are, let's say by middle of February. At that point, I think it'll be clear whether or not it's uncrossed and going the other way or whether the trend is confirmed and if it is, then I think we can start to wonder whether we are about to get a change of momentum.

Craig Hemke: I know a lot of folks have watched that gold-silver ratio, Ned, and so any change in that, a change of that trend would certainly be eye-catching for a lot of folks. I have another Craig follow-up question for you, though. As you are on the ground in London and very close to the physical situation there, as close as you can be since it's such an opaque market. You are famous...when I first found you, I saw you on a video talking at the GATA Conference in 2011 and you were talking about the futures market tail wagging the spot market dog, as a way of putting it. As we move into 2016, are you seeing any signs of renewed or continued physical stress in that gold market in London?

Ned Naylor-Leyland: Oh well, a lot has changed since then. I think the futures market has more dominance in where prices go now than it actually did before.

Craig Hemke: Seems so.

Ned Naylor-Leyland: Yeah and you can see that, as well, in the volumes traded in London, which although we don't get any data, really, from the LBMA, that is one thing they do publish and it has gone down. Now, one of the things I was seeing as physical type, because there were plenty and of course, a lot of the data's been removed and they're leaving one with nothing, really. Therefore, I tend to rely quite a lot on Sandeep's Basis calculations, which indicate extreme stress. Again, I think he emailed me yesterday saying that it was record, never seen things so back-rated...

Craig Hemke: That is Sandeep Jaitly, just want to make sure everyone knows who we're talking about.

Ned Naylor-Leyland: Yes, sorry, yes. I'm making leaps of assumption that..so he runs the Basis service which looks into the real quotes of the bullion banks in London and tries to get a sense of true liquidity that sits behind there. And yeah, he's seen the same problem, we've also clearly seen work which suggests that the free flow of physical labor and above in ETFs in London is almost nil, which would also tend to confirm, wouldn't it, what Ken Hoffman said, which was...gosh, that was two, three years ago now, but it was a while ago when he said there was very little around.

But when I speak to this particular point now, institutional level, it's important to frame it, I think, but not push too hard, because ultimately, while the market functions, the market functions. It's a bit like driving a car, isn't it? If it's got enough petrol to drive down the road, no one cares. It's only going to be when it stops and then they look at each other wondering, "What happened?" and the answer is, "Well, we've been saying for the last 50 miles, we may need petrol at some point." And that's how it feels.

The markets, certain institutions, people are very, very complacent about where things are, whether it's gold or not and these kinds of relatively arcane, esoteric are in the bullion market are not most people's taste. I think it's very interesting, it looks very dodgy from where I've sat but then again, it has for a while, so, a difficult, difficult one to answer.

Craig Hemke: What will it take, Ned, to finally see price determined, price discovered more on a physical basis than these paper markets? Do the paper markets need to fail? Does some other global central bank need to...speaking specifically about the Russians or the Chinese, do they have to make some pronouncements? What will, in your view, finally end the reign of terror of these paper markets in determining price?

Ned Naylor-Leyland: Well, I suppose there's two ways of thinking about that. One is the acceptable, system-led version of it, which would be some kind of monetary reset, which would be agreed by them. And I think that's a possibility. And the other is just some kind of, yeah, delivery failure.

Craig Hemke: Mhm. Do you sense the world is any closer to that than it was a couple of years ago?

Ned Naylor-Leyland: No, I don't think...I'm not sure I do, if I'm honest, despite what I said earlier about record degradation. I'm not sure I do think. I think the amount of silver that's being delivered from stockpiles to satisfy the market would tend to anecdotally make one wonder whether we're quite close with that. But I think the lack of demand for physical in Western financial centers at the moment is a constraint to that happening.

I think that will change and I think that will probably change in a considerable way very quickly, because we're relatively sheep-like in our investment behavior in the West. So I think that once people feel they need to be back in this space, then you'll see that problem manifest fairly quickly, because from a very small trickle, you'll see a rather large amount of capital trying to get into metal and then the likelihood of a delivery problem is compounded.

Craig Hemke: Be interesting to see the banks scramble for gold to put back into the GLD when that day comes, I suppose.

Ned, the final question that I've had sent in by some of the listeners, has to deal specifically with your area of expertise, which is the mining shares. They have been beaten down for years. The key index that I like to watch is the HUI, which got to six hundred and something a couple years ago and now it's, I think, 110, so it's a rather dramatic decline but perhaps looking like it is bottoming, finally. So this question has to deal, I guess, with picking winners or picking survivors, if you will, to profit from when the turnaround comes and specifically, the question is: with mining shares at multi-year lows, what are the key metrics that you follow in identifying a possible survivor for the years ahead?

Ned Naylor-Leyland: Well, obviously there are several - and it depends on the size of the company we're talking about. An exploration development company, which frankly, I think unfortunately at the moment are almost un-investable, and the reason for that is because even the good ones don't have enough cash and what they're looking for is a bounce in the underlying, at which point they're clearly going to issue more equity, which means they're very difficult, they're almost un-investable at the moment, I'm afraid.

Beyond that, what metrics? One's slightly forced to...so I was complaining about other people behaving like sheep and now I'm going to admit that in my sector, I am forced to also observe other people's key metrics, because of course, that's what moves the market. And it's also true to say that free cash flow yield is the market's preferred valuation metric at the moment. I would say the following, though, if you wanted to think about it in a more holistic way, I would say that, first of all, one mining share in this environment is very dangerous. And again, it's not about say, "Buy any fund that I manage," but if you want exposure to precious metals' mining shares, I would tend to say, own a basket, first of all, unless you're highly experienced, have analytical skills, you're a mine engineer and a geologist and all of these things wrapped up in one, you ought to be pretty cautious taking views on individual mining shares.

But look, management is crucial. There are a few companies which we really like, have overweight positions in, which are run by people who have a proper account cyclical view, that have high assets that have been under-performing, they're turning them around, you can see that, there's a track record for doing that, I think that that's something which we look for. At the moment, we'd rather own less companies that have a prudent track record for doing that.

And then obviously, the cash position is crucial. How much longer can they operate in these kinds of metal processing environments? Another key thing, which if you're looking at yourself, I would say is important to look at is what price deck are the company is using when they're looking at their internal metrics, because the horror show is the end of the year, when you realize that a company's actually been using a...I don't know, $1,350 gold price deck and $16.50 in silver and then they suddenly have to change everything.

So the problem with this as a sector, for the retailer, it's a very technical, a high barrier-to-entry thing to try to do, so I would just say, be cautious, certainly don't just own one and probably recognize one's skill limitations and tend to say, I'd rather own a fund, which can do it for me than go pining into it individual names myself.

Craig Hemke: Yeah, I think that makes a lot of sense, again. Given where we are, there's certainly some value there, but the challenge of picking winners, individual companies is critical.

Ned Naylor-Leyland: And actually, you know what, Craig, it's even more so the case now, because they are incredibly cheap and because there is enormous latent torque in a portfolio of mining shares. There's less, I would argue, there should be less temptation to try and stock-pick yourself, because the truth is, the people that run funds in the sector, broadly own all the good companies now. I can name you six or seven funds, including ours, that invest in this space, and really, we own pretty similar selection of equities. And the reason why is there now, at this point, aren't that many that are good and there are a lot which are running on fumes, and while one might be tempted to convince oneself that they're going to be fine, in truth, what's going to happen is they're just going to dilute and then you just get stuck.

So yeah, I would say right now the compelling opportunities to just be invested in gold and silver mining shares, that's enough of a counter - a contrarian play anyway and there's plenty of upside if you get it right.

Craig Hemke: That's an excellent point - that's an excellent point. Well Ned, thank you so much for spending some time with us. This has been some tremendous information that you've shared with everybody. I want to wish you a Merry Christmas, a great holiday season and a prosperous 2016, hopefully it'll be a little bit better than 2015.

Ned Naylor-Leyland: I hope so too. Merry Christmas to you and yours as well, Craig.


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