October 15, 2010 6:07 pm

Price of gold continues to rise and shine

The gold price hit another high this week as concerns mounted about the economic outlook, leaving investors facing the question whether to buy gold bullion or shares from the mining companies themselves.

Mining companies across Australia, South Africa and Latin America are drawing attention from buy-and-hold investors who subscribe to the theory that metal prices will be driven higher for decades to come, thanks to soaring demand from the emerging middle-classes in China, India and Brazil. Scores of speculators, meanwhile, are buying into gold-backed exchange-traded funds, hoping to see further upside in the gold spot price, which set another high of $1.387 a troy ounce this week.

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Opinions vary on whether mining or bullion is the superior bet. “At times, mining stocks and the gold price behave in very different ways,” points out Justin Urquhart Stewart, director with Seven Investment Management, who has turned bearish on the gold price. While rising spot gold prices push up mining companies’ revenues, their profit margins can be impacted by new taxes and regulations, higher costs and production problems. Just this week African Barrick Gold, the FTSE 100 miner, drew attention to the difficulties miners face when it cut its gold production forecast again after uncovering “organised and systematic” fuel theft at a Tanzanian mine.

But Paul Burton, managing director with the consultancy GFMS World Gold, argues that, on average, forecasts are rosy for gold miners. He points out that some even pay small dividends and offer leverage on the gold price. “Their costs have increased dramatically, but these companies’ margins are good for the most part,” he says.

Among mining companies, the valuations of established players such as BHP Billiton – which trades at 9.5 times 2010 earnings and pays a 2.5 per cent dividend; Rio Tinto – which trades at 9.7 times earnings; and Anglo American – which trades at 11.3 times 2010 earnings, still look inexpensive relative to other asset classes.

Gaining exposure to gold bullion has its attractions as well. The current rush to buy the yellow metal is being driven largely by investors seeking a hedge against both inflation and deflation or a proxy currency as foreign-exchange markets turn rocky.

Rupert Howard, head of UK portfolio management with Rothschild Private Banking, regards gold’s outperformance – in nominal terms – as something of a historical quirk. He argues that gold has little industrial use apart from in jewellery-making and dentistry, offers no yield and is exceedingly difficult to value.

But in spite of having watched the gold price more than quadruple in the last decade (in January of 2000, a troy ounce of gold cost just $280), Howard still believes its investment case is compelling. Demand for gold is expected to remain strong if – as expected – central banks introduce further monetary stimulus programmes, weakening the value of paper currencies and increasing the risk
of inflation in Western economies.

“Even after such a strong run, we . . . continue to hold significant positions within investment portfolios,” wrote Rothschild analysts in a recent note. “It is an effective hedge against further turmoil in financial markets at a time when an escalation of debt problems in the eurozone or a loss of confidence in the credit-worthiness of the US or Japan are real risks.”

With the gold price rising along with copper, tin and other commodities, the case for investing in natural resources funds is advancing as well. The returns thrown up by natural resources funds – which invest in a broad mix of hard commodities – look attractive to long-term investors.

In the last five years, BlackRock’s World Mining fund gained 143 per cent; First State’s global resources fund was up 131 per cent; and JP Morgan’s Natural Resources fund rose 136per cent, according to Morningstar.

Advisers argue that these vehicles tend to be a better long-term play as they offer the added benefit of diversification. “Buying into physical gold is more a play on real interest rates being low and the devaluation of the competitiveness of currencies,” says Mick Gilligan, head of research with the advisory firm Killik.

Indeed, the rally in gold is helping other precious metals, with silver hitting a 30-year high of $24.90 per troy ounce this week. Base metals have also performed well, with forecasts for the copper price looking increasingly rosy thanks to shrinkage in supply.

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