Mark Dampier: This small, flexible fund could be a little gold mine

The Analyst

Owning gold used to be fraught with difficulty for retail investors. Transporting, securing and insuring the bullion added to the cost and hassle of ownership. Traditionally, investors bullish on gold therefore bought shares in gold mining companies. This had the added advantage of exposing investors to a gearing effect. As the gold bullion price rose companies that kept their costs stable could make increasing profits on each ounce of gold mined. Higher earnings and profits can eventually translate into a higher share price.

Over the past few years two things have caused this relationship to break down. As easily accessible gold has been exhausted, exploration and production costs have risen, along with associated costs such as machinery, raw materials and labour. Secondly, the rise of exchange-traded investments has enabled retail investors to access bullion – and other precious metals – easily and cheaply.

In 2011 gold bullion did what it was supposed to do. As Western governments devalued their currencies, the price rose as investors sought a safe haven in a store of value that cannot be devalued by printing more.

However, the shares of gold mining companies behaved like normal equities. Investors sold them almost indiscriminately when "risk off" was in vogue. In times of risk aversion investors tend to sell their winners first, so smaller gold miners, which had performed well, fared worst.

Smith & Williamson Global Gold & Resources, which tends to have abias towards smaller gold mining companies, did not escape the maelstrom.

Performance has rebounded recently, but not enough to make up for 2011's losses. With 62 per cent exposure to gold, 23 per cent in other precious metals and minerals, and 13 per cent in metals and mining, this is not a pure gold fund. It is run out of Toronto which is home to more than 60 per cent of the world's gold miners. This proximity to company management and key decision makers is a tremendous advantage.

Despite a poor 2011, the team remain positive on gold. Production is still flat with no signs of an increase in supply. Furthermore, geopolitical risk, particularly in Iran; currency debasement via further quantitative easing ; and demand from emerging markets could keep demand buoyant.

The Chinese, for example, are buying increasing amounts of gold, both at a government level to diversify their reserves away from US dollars, while retail investors and consumers are also adding to the global demand for bullion and jewellery.

Indeed, demand for gold jewellery remains strong in other emerging markets such as India, while central banks across the world continued to buy gold in 2011. Constrained supply and rising demand is a recipe for rising prices.

The catalysts are in place for the gold bullion price to keep rising over the longer term. This bodes well for the ability of gold mining companies to continue growing their profits.

In my view, gold mining shares are like a coiled spring. They are poised to rise and narrow the gap which emerged during 2011 between them and the price of bullion, although I wouldn't rule out more short-term volatility.

The Smith & Williamson team believe that gold mining companies are cheap, at much the same levels as they were during the depths of the 2008 financial crisis.

Mining companies are earning healthy profit margins, and larger ones, such as Newmont Mining, have started to link their dividends to the price of gold.

Investors therefore have the added benefit of receiving dividends as well as the potential for capital growth.

While absolute yields are not high, there could be potential for growth and I believe that this is a further reason to be positive.

Given all the uncertainties in the world I continue to believe that part of a diversified portfolio should be exposed to gold.

This fund is flexible, relatively small, and in my view it is worth considering.

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