There are growing fears of a bubble forming in one of the only asset classes on an upwards trajectory over the past few years – gold. Can it really continue to appreciate in value from its heady heights? And is it too late now to get involved in this story?
Unsurprisingly, gold managers believe the rise in the price of gold will continue for some time yet. Some argue that investors should remember gold is not merely an asset class or commodity, but an alternative currency. In light of the ongoing volatility in the currency markets, it is this element that makes many managers optimistic that the gold price will continue to rise.
Angelos Damaskos, chief executive of Sector Investment Managers and fund adviser to Junior Gold investment trust notes that gold has been used as an alternative currency for a long time, traded most predominantly in times of crisis such as wars. While the crisis of today certainly doesn’t match that of a war-time climate, there is undoubtedly economic uncertainty.
Damaskos says that as long as the world economy continues to look bleak, he is unconcerned gold will stall in its upward momentum. He does not dismiss the idea it could see some setback, but he denies a bubble is forming in gold assets and believes the price could go significantly higher. He is not alone in that belief.
Ted Scott, director of UK strategy at F&C, acknowledges gold looks to be a crowded trade but notes that on a historic basis, sentiment does not look to be over-optimistic.
Scott says: “Gold’s attraction is that it continues to be a store of value in uncertain economic times. Traditionally, gold is viewed as a hedge against rising inflation and for this reason it remains a good each-way bet as the aggressive monetary policy of the central governments could eventually lead to rapidly rising prices.”
Gold is not merely a fallback in times of inflation but in a deflationary environment as well, where the return on other assets would be low and the risk of an extended global recession grows. “As gold does not provide any income the opportunity cost of holding it will be very low,” Scott adds.
Trevor Chanter, CIO at Way and manager of three funds of funds, holds Ian Williams’ Way Charteris gold fund across all his portfolios.
ighlighting another duality of gold right now, he notes he has included gold in both his cautious and growth mandates for opposite reasons – its simultaneous growth opportunity and defensive qualities. Although he holds around 4.5 per cent in the gold fund in each of his portfolios, plus a gold ETF in his cautious mandate, Chanter admits it is hard to dismiss all the bubble warnings so it is something he is monitoring closely. “If something goes up as strongly as gold has, obviously there will be bubble concerns. But those closest to this industry seem quite confident it has further to go.”
Certainly the supply and demand arguments for the gold price to continue rising are strong.
Damaskos says that he will only start to become concerned about the price of gold if there is a significant growth in the world economy, a significant reduction in unemployment and monetary tightening by central banks. None of these events look likely to happen at the moment.
No one knows where we are headed at the moment considering the massive problems we have experienced. Skeptics have talked of a bubble in gold ever since its price started to rise from its lows of $250 an ounce back in 2002. No one can tell a bubble without hindsight so in the meantime we have to look at the fundamentals,” he says.
Damaskos favours investing in gold equities as opposed to the alternative of physical bullion. “The commodity price rise has been so steep the valuation of the equities has not been able to keep up with this pace so there is scope for re-rating,” he says.
If the price of gold is at $1,350 an ounce and it costs a gold producer $750 to produce an ounce, then they are making $600 in profit. A price move to $1,650 would equate to a 22 per cent increase. But a company’s profit for every ounce produced would increase by $300, or 50 per cent, Damaskos points out.
Investec’s gold team make a similar point. Managers Bradley George and Daniel Sacks are focusing on those companies that display significant free cash generation, a production growth profile, as well as those which have implemented cost-control measures. “Companies that have these characteristics and that are now able to manage operating costs below $500 per ounce should exhibit improving operating margins. It is these companies which may show significant upside in 2010 – possibly by as much as double that of gold itself,” they say.
The two managers predict that there is even the possibility that certain companies may look to pay dividends, adding an income element to this story.
That is not to say that every gold miner or related company is a winner at the moment. Damaskos notes that there are lots of spin stories and early-stage companies claiming to have found new caches of gold. But obtaining gold from the ground is no easy matter, with many logistic and costly issues in the way -making such companies higher risk even with a buoyant outlook for the asset. There are also firms which are starting to look expensive, he notes. But Damaskos adds that there remain plenty of opportunities in this market.
While there is evidence that gold may indeed be the elixir for current market conditions, it is worth noting many fund managers are exercising caution. Therefore, unlike in previous bubbles – if this turns out to be one – most investors are probably not as exposed to the sector as they likely were to say, technology.
While physical gold is more easily held in portfolios today, it is still not widely held by mainstream funds and many exposures to gold miners are across the commodities spectrum, not merely focused on the yellow metal.
However, that situation may change if the gold sector remains the one area of the market in which to hide during what remains a very uncertain time.