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The bullion and the bear

Which supposedly shrewd economist sold an asset class back in the late 1990s, only to see it triple by 2007? Yes, you guessed right, the answer is Gordon Brown, who sold half the national gold reserves at about $250 an ounce. The current price is $752 an ounce.

To be honest, most politicians are economically illiterate and I think that cuts across all political parties. However, I suspect Brown, when he was still Chancellor, would have been well advised to speak with Graham Birch at Merrill Lynch before he offloaded our national reserves. Moreover, if he was intent on selling the bullion, I am sure Birch would have advised him to put a substantial portion of the proceeds into gold mining shares.

The benefit of investing in equities rather than bullion is that you are able to maintain leverage. Generally speaking, the profits of the mining companies are geared at least two times to the gold price. This assumes the companies have their costs under control and, to be fair, we have seen the costs of mining increase.

That said, I think it is interesting to see that when this fund was launched in 1988, gold bullion was around $450 an ounce. So the price of gold is up by around 67 per cent since 1988 but how has the fund performed over the same period? It is up more than 2,300 per cent.

At present, around 63 per cent of the fund is invested in gold miners, with just 2 per cent in gold bullion. Remember that although the fund may benefit from a rise in gold price, it will also be tied to fluctuations in world stockmarkets.

The fund also invests in stocks relating to other precious commodities, including platinum, silver and diamonds, which are also likely to benefit from a supply and demand imbalance and rising consumer wealth in emerging markets.

It is this imbalance which is creating what Birch calls a “perfect storm”. Of course, a number of other things have come together at the same time, including a weakening dollar that always favours gold.

However, as always, I think supply and demand fundamentals are the key issue. On the supply side, gold production peaked in 2001. Some 80 million ounces are mined each year while only 20 million ounces are discovered through exploration. Therefore, reserves are being depleted and production levels continue to fall. This state of affairs is likely to continue because it takes a long time (10 years plus) to get a mine in production and that is assuming you can find the gold in the first place.

Demand has been increasing, particularly from counties like India which use jewellery in marriage dowries. There is also a strong possibility that many of the emerging markets with huge foreign reserves – especially China – are likely to diversify away from the dollar and US treasury bonds.

It is hard to believe that gold will not be one of their diversifiers. Quoting Birch yet again: “A gold bar is like a bond that does not default.”

Ian Cochran, chief executive of Goldfields, the world’s fourth biggest producer, has recently said: “I am quite comfortable talking about $1,200 an ounce for gold in the next 24 months.”

I have no idea whether this will happen but it will be interesting to see what might happen to the unit price of Merrill Lynch gold & general. Bear in mind that if the bullion price had kept pace with the growth in the unit price, it would now be trading at more than $8,000 and ounce. Wow, now that’s a thought.

In conclusion, given the huge world imbalances today, it really seems to make sense from a tactical viewpoint to have some money in gold.

For the first time, I have bought gold in my self-invested personal pension. I realise that there are other gold funds around but the Merrill Lynch fund has always been my first port of call.

Mark Dampier is head of research at Hargreaves Lansdown


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