One asset that divides opinion time and again is gold. Investors tend to be either gold bugs or bears, with few in between. The bears have been calling the top of the market ever since gold reached around $500, doubling the level it was when Gordon Brown famously sold most of the UK’s remaining gold reserves.
The bears have continued to call the top with every rise of $100 since then. Yet, having now reached $1,900 an ounce, the dynamics of gold do not seem to have changed. There has to be some completely irrational buying for there to be a bubble and I see little evidence of this so far.
The fact is that Western currencies are being debased. Inflation is running far higher than interest rates, meaning the value of each dollar or pound is losing its spending power, and this trend is being exacerbated by the quantitative easing.
It isn’t anything new – the dollar has lost 97 per cent of its purchasing power over the past 40 years – it just seems the process is taking place faster than ever. Ben Bernanke candidly told us not to expect interest rates to rise for the next couple of years, so is it any surprise that the extreme levels of economic uncertainty have seen gold push up to new levels?
Although the strong case for gold persists, I cannot help but feel the opportunity has now moved to gold equities rather than bullion. The gold price is up by around 25 per cent since the start of the year but the FTSE Gold Mines index has only risen by 3 per cent. Some funds such as BlackRock gold & general are down by a couple of per cent and certain gold funds focused on smaller producers have fallen by 8-9 per cent.
Physical gold has rallied but gold equities have lagged far behind. The last time we saw a dislocation of this kind was during the credit crisis in 2008 when, after the initial stages of the crisis, gold equities roared back and went on to strongly outperform physical gold.
The average gold price was $1,224 per ounce in 2010 and the average production cost across the industry was $557 per ounce. Gold has averaged $1,496 per ounce so far in 2011, so even if labour and raw material costs have risen by 10 per cent or more, mining companies must surely be making higher profits.
Gold shares are also cheap based on historic valuations. Price-to-earnings ratios are much lower than they were in 2005, yet profits are rising strongly. One of the reasons why gold equities may have slipped out of favour is they have been caught up with the whole mining and commodities sector sell-off. We have seen quite large falls here, partly based on the increased danger of a slowing world economy. However, gold is not really an industrial metal and should perform differently to the likes of copper.
My belief is predicated on the gold price staying high. It is bound to fluctuate – rises and falls of more than $50 an ounce in this sort of environment are to be expected – but while real interest rates are negative and there are continued worries surrounding banks, I see gold remaining a popular investment.
Those looking for their first foray into the area might consider BlackRock’s gold & general fund, which is the biggest in the sector. Its size provides plenty of liquidity but does mean it will predominantly be invested in the biggest gold mining companies. Smith & Williamson’s global gold and resources fund is still reasonably big but has a greater number of smaller producers, which could perform better over the long term, although they can be more risky.
Finally, for those wanting to concentrate purely on smaller gold shares, junior gold fund and the WAY Charteris gold portfolio should also be beneficiaries of any sustained gold strength. These are much smaller and could be more affected by flows in and out of the funds – but they are also nimble enough to take full advantage of opportunities among the smaller producers.
Mark Dampier is head of research at Hargreaves Lansdown