Gold Shares Cheaper than Bullion, say Experts

Gold had a solid year in 2017, despite other asset classes stealing the headlines. Experts believe gold mining shares are undervalued compared with physical gold

David Brenchley 15 January, 2018 | 11:27AM

Gold bullion prices performed well in 2017, but gold miners offer value

Gold took a backseat in 2017, as risk assets like equities soared and bitcoin emerged. But gold has been quietly doing its job for investors in recent years - as an insurance measure for portfolios.

The price of the bullion appreciated 13% in 2017 to trade above $1,300. It’s up more than 25% from its latest trough at the back-end of 2015, but has traded as high as $1,900 in recent years.

Now, as equity markets look toppy, leading investment experts are becoming more positive on the outlook for gold. “It’s certainly something we’re warming to,” says Rory McPherson, head of investment strategy at investment manager Psigma.

Short-term factors that would increase the appeal of gold include higher inflation, as gold is widely seen as a hedge against rising consumer prices; and a pick-up in geo-political tensions around the world.

The spectre of rising interest rates and tapering of central banks’ quantitative easing policies will also bolster gold’s allure, according to Russ Mould, investment director at AJ Bell. He says the widely held belief that tighter monetary policy is not good for gold is “a total fallacy”.

In fact, he asserts, during the eight cycles of falling Federal Reserve funds rates, gold has on average gained 3% between the first and last cuts. However, during the seven cycles of higher rates, gold has on average gained 86% between the first and last increases.

“Gold is already up by 23% since Janet Yellen sanctioned the first hike of this cycle back in December 2015,” Mould adds.

The End Game For The US Dollar

The potential long-term decline of the US dollar is another tailwind for gold, says Tom Becket, chief investment officer at Psigma. “I think the end game for the US dollar has already started,” he claims. This would boost gold for UK-based investors because they buy gold in dollar terms.

Places like Russia and China are de-dollarising their economies. It was claimed last week that China would slow or halt purchases of US Treasuries, sending shockwaves through the bond markets. Becket says any following through of the threat would be bad for the dollar “given the Chinese are basically funding the US deficit”.

While China swiftly refuted the speculation, the shift of power from the US to the Far East is rapidly gaining traction. Becket expects China to usurp the US as world leader in both finance and politics sooner rather than later.

Elsewhere, Becket says Donald Trump’s tax reform packages are “frankly ludicrous”. “Bringing in less tax revenues at a time when US entitlements and defence spending is going through the roof make no sense whatsoever.”

All in all, Becket foresees a much weaker dollar over the next 15 to 20 years. “We’re going into a very interesting environment and in that environment gold could well be your best-performing asset,” he continues.

How To Play Gold

Both Becket and Mould agree that the way to take advantage of this is through gold mining companies, rather than bullion. Becket notes that these companies are currently “significantly undervalued by comparison to gold bullion prices”.

Mould adds: “Although gold rose 13% in dollar terms in 2017, the NYSE Arca Gold Bugs Index advanced by just 5%. That underperformance of the underlying metal left the Arca index-to-gold ratio at near 20-year lows.”

Meanwhile, Becket says that gold mining companies are much better run than they were a decade ago. “The old managers have been washed out and new ones have come in. Mining companies are now actually operating like proper companies, making profits and giving them back to shareholders.”

Investors can buy individual gold stocks, but there are few listed in the UK and they come with a higher risk warning. There are just two gold miners in the FTSE 350, Randgold Resources (RRS) and Centamin (CEY), while Fresnillo (FRES) produces gold as an offshoot to its silver mines.

But Mould points out that the world’s largest gold miners by market cap – Barrick Gold (ABX), Newmont Mining (NEM), Franco-Nevada (FNV) and Newcrest Mining (NCM) – are listed in North America and Australia.

A lower-risk way to play the theme is through collective vehicles, such as passively or actively managed funds.

Psigma’s current fund of choice is the active First State Global Resources. While it’s not a pure-play gold offering, it currently has 15% of its portfolio in gold miners, including a top-10 position in Franco-Nevada.

“We believe the fund is well placed to capture a large proportion of any upside, whilst also protecting client assets in more difficult market conditions,” says Daniel Adams, senior investment analyst at Psigma.

Mould says BlackRock Gold and General is the most well-known fund investing in gold miners. Morningstar analysts rate the fund Gold. The fund, managed by Evy Hambro, aims to find companies offering the best exposure to commodity prices within an acceptable level of risk.

“The fund continues to be a strong choice for investors seeking mainstream gold and precious metals equity exposure in a risk-controlled manner,” says Morningstar analyst Fatima Khizou.

Other active options include Smith & Williamson Global Gold and Resources, Investec Global Gold and Ruffer Gold.

“For those who believe gold miners are cheap relative to gold – and who are prepared to take on the additional risk posed by miners’ operational gearing to the metal’s price – there is the option of a tracker fund,” says Mould. These are “designed to deliver the return generated by a basket of miners, minus the instrument’s own running costs”.

Examples of these include ETFS DAXglobal Gold Mining (AUCO), iShares Gold Producers (IAUP), VanEck Gold Miners (GDGB) and VanEck Vectors Junior Gold Miners (GJGB).

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Barrick Gold Corp17.15 CAD0.29
BlackRock Gold and General D Acc811.45 GBP0.76
Centamin PLC101.90 GBX3.75-
ETFS DAXglobal Gold Mining GO ETF19.52 USD2.59
First State Global Resources B Acc GBP293.72 GBP1.67
Franco-Nevada Corp88.66 CAD1.88-
Fresnillo PLC865.00 GBX1.76-
Investec Global Gold I Acc Net GBP111.09 GBP0.83
iShares Gold Producers ETF USD Acc8.23 USD2.54
LF Ruffer Gold C Acc115.91 GBP-4.57
Newcrest Mining Ltd14.71 AUD6.83-
Newmont Mining Corp33.32 USD1.40
Randgold Resources Ltd6,408.00 GBX1.71-
Smith & Williamson Global Gold & Res B45.44 GBP0.92
VanEck Vectors Gold Miners ETF20.35 USD3.33
VanEck Vectors Junior Gold Miners ETF23.02 USD3.02

About Author

David Brenchley

David Brenchley  is a Reporter for Morningstar.co.uk