2011 was a volatile year for the gold price. It reached a high of over $1,900 per ounce in September but subsequently fell back to under $1,600. Over the course of the year it was up 8 per cent. The recent falls seem to be the caused by concerns about Eurozone debt returning to the fore. You would think the eurozone crisis would be positive for gold as it is often regarded as a safe haven in times of market turmoil. Furthermore, I believe it will eventually lead to quantitative easing in Europe, essentially the printing of new money which serves to devalue the currency. This should increase demand for gold as a store of value which cannot be debased by governments and central banks.
Investors, however, have decided to take short term refuge in the US dollar, somewhat ironic given the longer term structural challenges facing the US. It would seem the eurozone crisis has instead created the need for investors to have additional liquidity, and because gold is easy to sell it has seen the same flight to cash that risk assets such as equities have suffered. In my view the attractions of gold remain undiminished, and for this reason I believe the fall back in price will be temporary. It could therefore present a buying opportunity for those wanting exposure, although of course the price could fall further in the short term.
Buying physical gold or an ETF is one way to build exposure, but a more risky (and potentially more rewarding) way is shares in gold mining companies. A pronounced gap opened up between the price of gold bullion and gold mining shares in 2011. Whilst the gold price appreciated overall, gold mining funds fared far worse with BlackRock gold & general down 18.5 per cent and Smith and Williamson global gold & resources down by 27 per cent. Gold equities seemed not to go up much when the gold price rose but caught the full brunt of the metal’s falls.
Whilst gold itself is seen as a safe haven asset (though I use that phrase cautiously), mining shares are seen as much riskier. When markets become risk averse the gold price often rises, but this doesn’t necessarily translate into gains for gold mining shares. I don’t believe this disconnect can exist over the longer term, though. A higher gold price means greater profits for miners, and in the long run higher gold mining profits should mean higher share prices in the sector. Indeed many are now able to reward their shareholders with dividends. Newmont Mining, for instance, has linked its dividend to the gold price and others may follow suit. It could attract more investors to gold mining companies who traditionally used to invest most of their profits for growth, taking on further mine development or exploration.
Undoubtedly holders of funds such as BlackRock gold & general and Smith and Williamson global gold & resources have been disappointed by the fall in the price over 2011. I share that disappointment being a holder of the former. Yet I don’t believe the fundamentals for gold have changed at all. We have negative real interest rates around the world combined with an ongoing debt crisis in the West. These conditions are likely to persist for quite some time. It is hard to see Central Banks pushing interest rates up significantly in the next 2 years, and in Europe they could even fall further.
Evy Hambro, the manager of BlackRock gold & general, is more bullish on prospects for his fund than I can ever remember. He compares gold equities to a “coiled spring” ready to bounce back strongly. Cynics will conclude, “Well he would say that wouldn’t he?” Yet he has nothing to gain in terms of his long term reputation by making statements like this without truly believing them. Given the price action over the last 12 months I am inclined to agree with him that a significant opportunity is presenting itself. However, gold remains a volatile asset class, and the shares of gold miners even more so. Therefore clients shouldn’t allocate more than around 5 per cent of their portfolio to this specialised area.
Mark Dampier is head of research at Hargreaves Lansdown