Mark Dampier: Mines a rich seam as gold looks set to keep its glow

The Analyst

Last year was a volatile one for the gold price. It reached a high of more than $1,900 per ounce in September but fell back to less than $1,600. Over the course of the year it was up 8 per cent. The recent falls seem to be caused by concerns about eurozone debt returning to the fore. You would think the eurozone crisis would be positive for gold as it is often regarded as a safe haven in times of market turmoil. Furthermore, I believe it will lead to quantitative easing in Europe, essentially the printing of new money which serves to devalue the currency. This should increase demand for gold as a store of value which cannot be debased by governments and central banks.

Investors, however, have decided to take short-term refuge in the US dollar, somewhat ironic given the longer-term challenges facing the US. It would seem the eurozone crisis has instead created the need for investors to have additional liquidity, and because gold is easy to sell it has seen the same flight to cash that risk assets have suffered.

In my view the attractions of gold remain undiminished, and for this reason I believe the fall back in price will be temporary. It could therefore present a buying opportunity for those wanting exposure. Buying physical gold or an exchange-traded fund is one way to build exposure, but a more risky (and potentially more rewarding) way is shares in gold mining companies. A pronounced gap opened up between the price of gold bullion and gold mining shares in 2011.

While the gold price appreciated overall, gold mining funds fared far worse with BlackRock Gold & General down 18.5 per cent and Smith & Williamson Global Gold & Resources off 27 per cent. Gold equities seemed not to go up much when the gold price rose but caught the full brunt of the metal's falls.

While gold itself is seen as a safe-haven asset (though I use that phrase cautiously), mining shares are seen as much riskier. When markets become risk averse the gold price often rises, but this doesn't necessarily translate into gains for gold mining shares. I don't believe this disconnect can exist over the longer term, though. A higher gold price means greater profits for miners, and in the long run higher gold mining profits should mean higher share prices in the sector. Indeed many are now able to reward their shareholders with dividends. Newmont Mining, for instance, has linked its dividend to the gold price and others may follow suit. It could attract more investors to gold mining companies.

Holders of funds such as BlackRock Gold & General have been disappointed by the fall in the price over 2011. I share that disappointment, being a holder of BlackRock. Yet I don't believe the fundamentals for gold have changed. We have negative real interest rates around the world combined with a debt crisis in the West. These conditions are likely to persist. It is hard to see central banks pushing interest rates up significantly in the next two years, and in Europe they could even fall further.

Evy Hambro, the manager of BlackRock Gold & General, is more bullish on prospects for his fund than I can remember. He compares gold equities to a "coiled spring" ready to bounce back strongly. Cynics will conclude, "Well he would say that wouldn't he?" Yet he has nothing to gain in terms of his long-term reputation by making statements like this without truly believing them. Given the price action over the past 12 months I am inclined to agree with him that a significant opportunity is presenting itself. However, gold remains a volatile asset class, and the shares of gold miners more so. Therefore investors shouldn't allocate more than around 5 per cent of their portfolio to this specialised area.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent

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