In a dangerous time, gold still shines brightly for investors

INVESTMENT COMMENT

THE current bull market in gold has been running for over a decade and, after a recent correction, shows little sign of stopping. Gold bottomed at around $250 an ounce in July 1999. Since then, gold has risen over 450 per cent, to around $1,400 an ounce.

One of the most significant drivers of this long up-trend is investment demand and, given the poor returns from financial markets over the last decade and the level of economic uncertainty globally, it isn’t hard to see gold’s safe haven appeal.

Another key factor in the price of gold is currency devaluation. The US Federal Reserve, fearful of deflation and a double-dip recession, has once again embarked on quantitative easing (money printing). The US isn’t the only country that has been devaluing its currency – gold has made big price gains against every major currency in the last ten years, by 384 per cent in sterling and 257 per cent in euros.

Gold offers a store of value in an environment where record low interest rates mean that holding cash is no longer “risk free”. Five of the six largest economies all have negative real interest rates – where holding cash loses purchasing power.

The companies that produce gold offer investors upside leverage to a rising gold price. That’s because as a stockholder, you not only get a share of the gold the company currently produces, but also an interest in all the ounces in the ground that are yet to be mined and all the ounces that the company is yet to discover. This leverage means that gold stocks usually move more than the gold price. For those that don’t want to pick individual stocks, there are several gold exchange-traded funds (ETF) that do that hard work for you (see table).

These ETFs provide investors with exposure to a basket of gold companies. All three include Barrick Gold, Goldcorp and Newmont Mining among their top 10 holdings. These companies are top gold producers with an average cash cost per ounce of production of $403 and combined gold reserves of 284m ounces. These names make up 37 per cent of the Market Vectors and DAXglobal funds but only constitute 22 per cent of the PowerShares ETF. Other notable companies held by all three funds include: Yamana Gold, Agnico-Eagle and New Gold all of which are great gold producers. Yamana for example has a cash cost per ounce of production of just $125.

The PowerShares ETF holds a total of 68 companies, giving it exposure to many of the smaller exploration companies such as US Gold, which has recently announced some excellent drill results from Nevada and Mexico. The fund does however have the highest expense ratio of the three.

The DAXglobal fund is more concentrated, allocating 79 per cent of its assets to its top 10 stocks and holding just 21 companies – more than half of which are listed in Canada. The fund also holds some intermediate gold producers and has the largest allocation to the intermediate producer New Gold which has an excellent management team, some great development projects and is in a joint venture with Goldcorp.

The Market Vectors ETF is perhaps the best known of the three funds and also has the lowest expense ratio. The ETF holds 31 companies, including some smaller but fast-growing producers such as Minefinders, which operates the multi-million ounce Dolores mine in northern Mexico and expects to expand production from 100,000 ounces to 500,000 ounces in the next five years. The fund also includes the excellent Silver Wheaton in its top 10, a royalty company which provides considerable leverage to increases in the price of silver. Thanks to its low costs and good range of large to small cap gold stocks the Market Vectors Gold Miners ETF would be my choice.

Ben Mountifield is the author of The Mountain Investor Report, a monthly newsletter covering all aspects of investing from property prices to precious metals.

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