International Herald Tribune: For canny gold buyers, it's time to mine

For canny gold buyers, it's time to mine
By Barbara Wall International Herald Tribune
Tuesday, March 8, 2005

You do not have to be a gold bug to realize that gold and precious metals should do well this year. But you might also want to reserve some space in your portfolio for industrial mining companies because, according to fund managers, their star is also rising.

Gold bulls had a great run in February, with the price hitting a high of just over $440 an ounce in the past week. Fund managers predict that the upward trend in metals will continue as central banks, particularly in Asia, diversify away from the dollar and buy gold and platinum to bolster confidence in their currencies.

The recent appearance of gold-linked exchange traded funds has opened up the sector to institutional and retail investors. StreetTracks Gold was introduced at the end of 2004, while Barclays iShares Comex Gold Trust made its debut in January. The investment concept is simple enough: The funds buy physical gold and the shares reflect the changing price of the metal, minus expenses.

For a minimum investment of $10,000, investors could get direct exposure to gold and other precious metals through an open-ended investment fund like the Aliquot Gold Bullion Fund, managed by Castlestone Management. An additional advantage is that Castlestone leases out its gold holdings during the month and uses the leasing income to offset fund costs.

Daris Delins, a director at Castlestone Management, said that a gold bullion fund was similar to hedging against a paper currency investment.

Most investors think of gold equities when they think of gold as an asset class," Delin said. "However, gold-related equities funds are two to three times more volatile than a pure bullion fund. When you buy mining company stock, you add an extra layer of complexity to the portfolio. As well as getting exposure to the metal, you are also exposed to foreign currency risks and management issues."

Aliquot Gold Bullion rose 4 percent in the three months to the end of February, while the average offshore gold equity fund lost 8 percent over the same period, according to Standard & Poor's.

Gold equities tend to follow, though not mirror, the direction of the gold price. Last year, the relationship decoupled. Evy Hambro, manager of a mining equities fund for Merrill Lynch, in London, explained: "Gold equities went through the roof in December 2003, as analysts were predicting the collapse of the U.S. dollar. When this failed to materialize, valuations came under the spotlight, and share prices suffered. "

Managers generally like gold companies because many pay dividends. In good times, shares can also do better than bullion because companies are leveraged. The main problem at the moment is that valuations are still considered to be on the high side. Eberhard Weinberger, manager of a gold and resources fund for DJE Investments in Germany, said a catalyst was needed to push gold shares higher.

"A significant rise in the gold price or a further weakening of the dollar could help matters, but investors need to be selective," Weinberger said.

"I would go for defensive blue-chip names, such as Anglo Gold, as they tend to do better in periods of high volatility."

It is not just the gold price that is replete with possibilities. Hambro said that he expected it to be a "fantastic" year for industrial mining companies on the strength of their improved earnings.

"Mining companies that focus on base metals and industrial materials are making money faster than they count it," he said.

"Earnings at Anglo American and Rio Tinto were up 59 percent and 61 percent respectively on last year."

This is not just a one-time thing, Hambro added. Assuming that commodity prices remain fairly stable, he predicted that earnings growth over the next few years would be huge. But will this lead to higher share prices?

"We believe higher than long term average commodity prices should be around for a while," Hambro said. "This means that mining company share prices could be due for a significant rerating. At one point the sector was trading on 16 times future earnings. It is now trading on just 10 times."

And if Hambro is proved wrong, shareholders are unlikely to be too disappointed.

Analysts expect mining companies to return significant cash to shareholders over the coming years, given high commodity prices. Teck Cominco increased its dividend by 100 percent last year and Rio Tinto has just announced plans to return $1.5 billion of capital to shareholders over two years through a share repurchase program. Now that is food for thought.

Prudent Investor comments...Oh no! Mainstream media is now into it...a bad sign.