Benefit from the gold rush through miners

AS THE Eurozone lurches from crisis to crisis, the price of gold hit an all-time high this week at $1,250 an ounce. With many analysts predicting a further surge to $1,300 or $1,400, investors are flooding into the gold market and physical gold-backed ETFs. In the rush, many have overlooked what could be an even better way to profit from market anxiety: gold miners ETFs.

Not all gold miner shares have done as well as gold during the recent surge, largely because of a general nervousness about equities. For example, Van Eck Global, a US-based ETF provider, has a gold miners ETF, which is up 10 ?????per cent year-to-date, during which gold has risen 14 per cent. But there are solid reasons to think gold mining equities will outperform gold.

For one thing, many miners have seen their costs drop as the markets flee commodity currencies. Operators in South Africa, Australia and Canada have benefited in the last year as their currencies weakened against the greenback, in which gold is priced. And as long as the recovery remains uncertain, the dollar will continue to strengthen alongside gold.

Further, miners have been preparing for an anticipated jump in gold prices by increasing their sensitivity to the market. Traditionally, gold miners have hedged against gold to protect themselves from the commodity’s high volatility, but in the past year major producers have been eliminating hedges, with Barrick Gold planning to get rid of $1.9bn worth of gold hedges altogether by September 2010.

Added to this is the low marginal cost of increasing production – once a mine is built, it costs little to speed up extraction – and gold miners look set to win big from the fear gripping global markets.

In turn, ETFs that track gold mining indices have swelled over the past year. ETF
Securities’ gold mining fund, which tracks the Daxglobal gold mining index, has risen 17.3 per cent over the past year (and 9.4 per cent in the last quarter alone) while PowerShares’ Global Gold and Precious Metals Portfolio has jumped 33 per cent.

Meanwhile, with gold miners’ margins expanding, Van Eck Global has expanded its gold mining offering and last year started another fund – the Junior Gold Miners ETF. The purpose of the junior version is to take advantage of smaller mining companies engaged more in exploration. Van Eck’s Edward Lopez says: “Gold production has been in a bit of a decline since 2000-2001 and it’s been hard for gold producers to replenish their stocks as the rates of discoveries has gone down.” As a result, “the explorers and recent developers are looking for new gold mines to establish extra production and because of that they are more risky, but they offer a new dynamic in terms of risk and return”.

Gold mining then, can be far from the risk-averse outlook of typical physical gold buyers. Much of the recent surge has been driven by institutional investors such as pension funds attempting to back up their equities with a safe underlying asset. Of course, as a store of value, gold is essentially just another currency dependent upon market confidence. But at least, as Lopez points out: “It’s the world’s reserve currency and it’s the world’s oldest currency. It can’t be mass-produced – so governments can’t muck up the value of it.”

And with gold set to rise over the next year as sovereign debt problems continue to plague the western world, gold miner ETFs offer a viable equity alternative to joining the gold rush.