Gold still gleams in the macro murk

It is not just the rise in demand for gold but also the monetary policies of governments that will keep the bull run on the precious metal going, according to Smith & Williamson’s Ani Markova.

PATRICK COLLINSON The Guardian Personal Finance Editor

Nothing seems to arrest gold’s steady climb. Over the past year it is up from $1,100 to $1,530 an ounce, and Ani Markova, a joint manager of Smith & Williamson’s Global Gold and Resources fund, reckons that we are still only part-way through the great bull run.

Global Gold & Resources is the minnow of the UK gold funds sector, with just £63m under management, although in reality it’s a mirror fund of a Toronto-based group, AGF, which has assets of more than $50 billion (£30 billion). Its performance has been sparkling. It’s up 26% over the past year, comfortably edging ahead of its much bigger cousins, BlackRock Gold & General and JPM Natural Resources, although it trails SF t1ps Smaller Companies Gold, which is up 66% over the past year.

That should give you a clue to the S&W fund’s outper-formance; it’s further down the market capitalisation scale than its bigger brethren. More than 50% of the fund is in sub- $1.5 billion market caps, and just 29% in the majors with market caps above $5 billion.

After a long fall in production, gold output started to rise significantly after 2008 in response to rising prices. Global production has since surged by nearly 15%, but research by AGF sees that rise tailing off. At best, total output will rise by a few percent a year, which will fail to meet the rise in demand from emerging markets, particularly India and China. Jewellery demand has remained mostly firm in the face of rising prices, while investment demand and central bank buying have moved ahead strongly.

But the supply/demand dynamic is almost less important to Markova than what is happening to global money supply and inflation. “What’s perhaps different about this fund to its main competitors is that we try to marry the top-down macro picture with the bottom-up stock story,” she says. “The gold price is being driven by fundamental uncertainty and financial distrust, alongside the large amount of liquidity in the global system.” (Collinson continues below)

She points to a slew of data that suggests governments around the world, particularly in the West, are playing fast and loose with monetary policy. Some of the figures are particularly compelling. While we’ve all been watching Greece, Ireland, Portugal and Spain, perhaps we should have been looking at Washington instead. America’s federal deficit is colossal, even worse than Britain’s, with little indication that the government is inclined to do anything about it.

Federal taxes as a percentage of American GDP are about 17%, while central government spending is closer to 25%. That’s a huge gap, and Markova can only see it getting worse, with pension and healthcare entitlements ballooning in a country so ideologically tuned against tax rises. Unfunded Medicare and Medicaid commitments are $55 trillion.

America’s budget deficit will be about 11% of GDP in 2011, while Israel’s will be 9%. At the same time, both countries’ governments have massively eased monetary policy, and in America there is talk of a third round of quantitative easing (QE3) as the economy flags again.


This all points one way, says Markova – to inflation, and further rises in the price of gold. “QE is bringing more fuel to the fire, it only prolongs the day when econo mies have to face up to global imbalances and restructure debt.”

A big worry for many investors, though, will be the fact that gold has risen so much already. Buying a fund like this surely means they are buying into a late stage of the cycle? Markova meets the “gold bubble” argument head on. She has analysed data going back to 1800 and the shortest length of a bull run in gold is 10 years. We’re nearly at that point now, so if it has peaked it will be the shortest-ever bull run in gold.

We’re about 110 months into the bull run, and the price of gold has gone up sixfold or so. But overlay that on to a graph of the bull run in technology stocks on Nasdaq before 2000 (it went up 16-fold over the same period) and you can see that if it’s a bubble, it’s still a relatively small one.

In inflation-adjusted terms, gold is a long way short of its early 1980s peak of $2,500 in today’s money. That’s only partial comfort, though – pretty quickly the bubble burst and the price fell nearly 80% in the next three years.

Of course, this fund is not invested in physical gold but in gold equities, which have trailed the metal itself and represent remarkably good value.

“Gold equities are trading at around 10 times earnings,” says Markova. “This is a fantastic entry point, at a time when they are increasing dividends and becoming much more attractive to funds seeking an income.”

Margins at the main gold producers have surged in recent years. Even after the price of gold began to recover, all-in costs of production regularly exceeded the spot price. But since 2005, despite production costs per ounce rising dramatically, they have been far outstripped by the spot price.

The typical profit margin per ounce jumped to $179 in 2008, then nearly doubled to $328 in 2010.

Producers that can keep costs under control while enjoying super-high prices will be hugely profitable, which is why Markova is a keen buyer of Osisko Mining in Canada. Commercial production began only last month, with costs coming in on budget. It will be the country’s biggest gold mine and was hailed last week by Canada’s Financial Post as “proof that the Canadian mining industry works”. Osisko did not even begin exploration at the site until 2005, when it was a penny stock. Today it’s trading at over C$14 (£8.70).

It’s interesting just how much of the world gold mining industry is traded on the Toronto exchange. Canadian-listed companies make up 60% of global market cap in the sector, so Markova’s base in Toronto makes a lot of sense.

Whether gold will make sense for much longer is debatable, but what is even less clear is why so much investor cash goes into BlackRock’s fund and so little into this one. There’s certainly an argument for spreading some of it around.