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The end of the yellow brick road?

Fears gold prices could be peaking are seeing some investors switch out of the metal, says Joanne Ellul

Gold is performing strongly as investors flock to the commodity amid a depreciating dollar, low interest rates, high inflation and volatile markets.

Further short-term increases in the price of gold are predicted. However, some fund managers are taking profits and making tactical switches away from the precious metal.

The price of gold has jumped by 28 per cent this year, up from $1,421 per ounce at December 31, 2010 to $1,816 at August 18, 2011.

Addressing fears that the price of gold could be peaking, Blackrock manager of the £2.9bn gold & general fund Evy Hambro says that taking into account the price of gold at its peak in 1980, it should be trading at $2,500 an ounce on an inflation-adjusted basis. In an investor note published earlier this month, JP Morgan predicted gold could hit $2,500 later this year.

Alongside market volatility, Hambro says the limited supply of gold is pushing up prices.

He says: “Central banks have been buying gold versus selling gold for the last two to three decades, jewellery demand is very strong and production is flat. Production has only just got back to the level it was 10 years ago recently and the mines are struggling with demand.”

Hambro says goldmining shares may have lagged the gold price this year but this has also been the case with other commodity equities such as oil and copper.

He says: “It is much more of an equity issue than a gold issue as we have seen a general de-rating of equities this year. History shows these gaps tend to close in one of three ways, either the commodities come down, the share price goes up or both happen simultaneously.”

JP Morgan fund manager Neil Gregson, who runs the £4m JPM global mining fund, has added to his weighting in gold mining shares as their performance has lagged. The JPM global mining fund had 17 per cent in gold equities in June and last month Gregson raised this to 22 per cent out of a total 25 per cent weighting in precious metals.

He says: “Given the lagging performance of gold shares, we added to our weighting in the mining fund in expectation of an upturn in the market. Gold companies back in the ’90s were quite expensively valued and because they under-performed gold, the valuations have come down a lot and now they are fairly cheap.”

The £2.6bn JPM natural resources fund’s weighting in gold shares has remained static at 32 per cent out of a 38 per cent allocation to precious metals.

Investec head of the global commodities and resources team Bradley George says seasonal demand for gold may drop off in the coming months.

He says: “One negative aspect of the recent run in central banks buying gold is that it may have cannibalised some of the strong seasonal demand that would normally come from the Indian physical market from September.

“The remainder of the year may therefore turn out to be less explosive in terms of demand than we have seen in prior years.”

George predicts a gold price average of $1,550 per ounce for 2011 and 2012 and an average of $1,300 in the long term.

Cazenove head of multi-manager Marcus Brookes says high gold prices and a volatile market present an opportunity for managers to pick up cheap equities.

Brookes says: “Gold is up by 20 per cent year to date. There are cheaper areas to invest in and if there is a bounce-back, gold comes off and some equities that have underperformed will have a bit of a rally.”

Brookes cut the gold weighting in the firm’s multi-manager portfolios by up to 1.5 per cent in the second week of August. The £588m diversity fund’s gold weighting came down from 3.5 per cent to 2 per cent while the £39.9m diversity tactical and £194.9m global (ex UK) funds’ weightings fell from 4 per cent to 3 per cent.

Rathbones investment director David Coombs also sold some of his gold exposure earlier this month when it hit $1,800. He reduced his 4 per cent position in the £33m total return and £52m strategic growth fund to 3 per cent.

He warns that the unpredictable nature of gold could see it plunge in the next few weeks. He says: “In terms of gold price, I think $2,000 to $2,500 per ounce is possible. However, the gold price is hugely unpredictable as demonstrated by its drop in the 1980s. Gold could lose 30 per cent in a matter of weeks.”

Coombs says his plan is to see his gold position as a source of cash.

BestInvest senior adviser Adrian Lowcock suggests investors looking for gold exposure will currently get much better value from shares than tracking the commodity through an exchange-traded fund.

He says: “As gold has had a strong run in the last few weeks, it is looking a bit pricey, so investing directly into the commodity could be risky. Why buy gold at $1,700 an ounce when you can access the shares, which value gold at $1,500 an ounce? That margin will close up, with either gold falling in value or the shares rising. Investors would rather be in shares when that happens.”



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