Analysis: Has gold lost its lustre?

Gold funds have suffered this year as investors have turned their attention to global growth. But not all experts agree that the metal’s current low price represents a buying opportunity

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Gold funds have had a tough start to 2013, hit by a combination of the price falls that have blighted the commodity throughout the year and a wave of redemptions from nervous investors.

Gold started its downward trajectory last October, when it was trading at $1,792 an ounce. It fell through $1,200 last month, to its lowest level in almost three years, after the US Federal Reserve said it could start winding down its $85bn-a-month bond-buying programme.

It seems the market woke up to the fact that interest rates would not be low forever. This fuelled the drop in the gold price, as the prospect of less money being printed has made the metal less attractive as a “store of value”. With rising rates, investors recognised the value of other asset classes compared with gold.

This year, as investors have cut their gold exposure and become more positive on global growth, gold funds have suffered. Looking at those funds focused in the yellow metal in the specialist sector, the popular BlackRock Gold and General fund has lost about 40 per cent this year.

However, BlackRock portfolio manager Evy Hambro says there are still reasons to be positive on gold over the medium to longer term and that its advantages as an inflation hedge, safe haven asset and portfolio diversifier still apply. He says: “The consequences of quantitative easing across the world today have yet to be fully realised. As inflationary pressures become more relevant in the world, we would expect demand for gold to rise again.”

Hambro says gold mining companies are also making changes that he thinks will improve their profitability in the future. “We are beginning to see evidence that capital expenditure is being deferred, operating costs are being cut, growth projects delayed and loss making production cancelled. As the market becomes more focused on inflationary pressures, which are likely to influence the gold price to trend upwards, these companies should be well positioned to deliver margin growth and free cashflow.”

Hambro says that as the companies deliver on these metrics, investor confidence in the sector should be restored, which should push up share prices.

The gold fund that has fared best this year is Investec Global Gold, falling only about 37 per cent. Second to this comes the BlackRock fund. The Way Charteris Gold Portfolio fund has fallen more than 45 per cent, while two funds have lost over 50 per cent – the MFM Junior Gold Trust 55 per cent and the Ruffer Baker Steel Gold fund 54 per cent. Ruffer Investment says it is using a defensive strategy to withstand the pressure on the gold price.

A Ruffer spokesman says the fund’s long-term and value-orientated investment philosophy remains unchanged, adding: “The portfolio is structured to ‘weather’ the current pressures on the gold price and equity capital markets environment, with the portfolio focused towards companies with resilient balance sheets and returns-focused management.”

Sector Investment Managers chief executive Angelos Damaskos, manager of the MFM Junior Gold Trust, has a similarly defensive approach. “We have focused on companies with sustainable cashflows and relatively manageable operating costs. There has been an escalation of these costs for gold miners, which many failed to anticipate,” he says.

Damaskos invests in companies that can still be profitable if gold trades at about $1,000. However, he remains positive on the commodity and says that macroeconomic uncertainty could see it touch and even exceed its previous peak of $1,900, as it is still seen as an “insurance policy” for investors.He says that the “price at these levels represents an outstanding entry point for gold, because the economic problems are far from being resolved. There is still the general indebtedness in the developed world. The eurozone is still in recession and the banking sector is under-capitalised”.

Bestinvest managing director of business development and communications Jason Hollands is not convinced by those commentators who assume that because gold has fallen sharply in recent months it now looks like a buying opportunity. He says there are significant headwinds facing gold. “There is an inverse correlation between the US dollar and gold prices. Gold is priced in dollars, which means a strong dollar makes it less affordable to the rest of the world, reducing demand.”

Hollands adds: “The largest market for physical gold is India, where it is traditionally purchased for the wedding season. Recently, the dollar has been strengthening and the Indian government have been hiking import taxes on gold.”

Barings portfolio manager Andrew Cole trimmed his gold ETF position in the Baring Multi-Asset fund at the beginning of this year, from 5.5 per cent to 1.5 per cent to put more money into the equity markets.

Cole could sell out of his remaining gold position, as he sees it as a “source of funds”. He says: “We wish we had sold all of our gold position. Given the recent weakness in equity markets and the volatility we have seen, we are waiting for the near-turbulence of our transaction costs to come down to use gold as a source of funds. We could sell it to buy into equity and bonds that are looking attractive.”

Cole says that for interest in gold to revive there has to be more financial distress – perhaps in China or Europe – rather than inflation, as expectations of inflation have not changed.

It seems investors have been ready to take more risk by looking elsewhere for better returns. The volatility of the bullion price and difficulties facing mining companies seem to have caused gold, for now at least, to lose its lustre.