Best of Ghost Mail: Gold vs. glitter

Investors are desperately looking for safe places to put their money. Herd mentality is a dangerous thing, with no greater examples right now than the gold and luxury sectors. But are they really similar at all?

Gold and luxury. They sound related, but they aren’t really linked at all from an investment perspective. Aside from the gold that perhaps makes it into some of the jewellery sold by the likes of Richemont and LVMH, there’s no obvious fundamental link.

I love… gooooooold

It’s impossible to think about this asset class without remembering the Goldmember movie. If that reference passed you by, then you’re probably too young to need any gold exposure anyway. 

Gold is driven by… well, I’m not quite sure these days. Nobody really is. 

The thesis of gold as an inflation hedge has been found wanting, as inflationary environments lead to higher interest rates and this tends to make gold less appealing as a non-yielding asset. It’s even worse for the gold miners under those circumstances, as the costs of mining increase but the gold price tends to stay stubbornly low. 

Is gold a safe haven rather than an inflation hedge? Perhaps. But as someone who held gold through the initial newsflow around the invasion of Ukraine and watched it do absolutely nothing, I’m not convinced that it does much in terms of catastrophe insurance for a portfolio. 

There was also a time when people thought that Bitcoin might be the new safe haven play, though that liquidity has largely been washed away by post-pandemic economics. 

The argument is also made that the US dollar is the world’s safe haven asset, with some yield to boot if you buy US Treasuries. If you trade those treasuries rather than hold them to maturity though, you can end up like Silicon Valley Bank: dead. 

In reality, the lack of bulletproof explanations for movements in the gold price is exactly why investors tend to like the yellow stuff. Correlation to other asset classes is low, so those looking for a “stay rich” portfolio with balanced exposure tend to make an allocation to gold. Those looking for a “get rich” portfolio usually avoid it unless they are actively trading the exposure. 

And this brings us neatly to 2023: the year when gold finally delivered the returns that some had been so patiently waiting for. A fun fact is that DRDGOLD is trading around 80% higher year-to-date, a spectacular run of form. An equally fun fact is that the price is not even back to June 2020 levels. A third fun fact is that if you draw a long enough chart, you’ll find that the price was similar back in 2004!

Now, DRDGOLD is a tailings business with lower margins than the companies getting the yellow stuff out from deep underground. This means a small net profit margin and hence the law of small numbers kicks in, where a seemingly modest change to gross profit margin can cause massive swings in net profit. This makes it volatile and dangerous for those who chase the gains without understanding the stock.

Even if we look at names like AngloGold, Pan African Resources and Harmony, we see gains of roughly 30% to 60% year-to-date. Again, draw a long enough chart and you’ll see the cyclical nature coming through. Buying at the top of the cycle can be very painful.

What about luxury?

Now this is a different story entirely. Unlike gold which is a glorified lottery, companies like Richemont and LVMH have underlying fundamentals that can be understood.

They also aren’t as similar as people tend to think. LVMH’s key business is Louis Vuitton, which means the biggest exposure is to fashion and leather goods. At Richemont, we are looking at primarily a jewellery and watchmaking company. It’s little wonder that rumours of a super merger in this industry never seem to disappear.

An even more interesting insight is that LVMH’s current growth in the US is being primarily driven by Sephora, a cosmetics retail chain that operates at net margins that are no different to any other health and beauty retailer!

Overall, the luxury sector companies are cash generating machines that have incredible resonance with the world’s wealthiest people. Those people aren’t shy to throw money at their problems, this much we know for sure. And perhaps the most interesting point of all is the importance of emerging markets to this story, with the top layer of wealth in places like Asia and Africa representing a lucrative target market for the likes of LVMH.

Watch out for China’s contribution in the next financial year. Although much of it seems to have been priced in, Richemont just signed on a record year on key metrics and the recovery in China only really came through in the fourth quarter of the year.

If you forced me to choose…

Whilst I am somewhat allergic to buying into charts that have shot up like this, there’s only one winner for me with anything more than a near-term lens: luxury rather than gold. From where I’m sitting, handbags pay more reliable dividends than yellow metals stuck in the ground.