How to invest in gold mining shares
Investment demand for gold is growing as investors step up their search for alternative stores of value away from depreciating US Dollars, Euros and Sterling. These currencies are losing their appeal as a result of further quantitative easing, low interest rates, rising inflation and fiscal imbalances. There are many ways for investors to gain exposure to gold including investing in ETFs, buying bullion and investing in shares of gold mining companies. As more and more investors buy gold coins and ETFs and switch their investments to this traditional store of value, the relatively small supply of the yellow metal, as well as gold mining shares, pushes their prices higher. This trend could last for several years as the world comes to terms with its deeply-rooted financial and economic problems.
According to the World Gold Council, global gold consumption in Q3 2010 grew by 12% over the previous year. Demand for gold jewellery increased by 8%, with four main markets – India, China, Russia and Turkey – accounting for 63% of global demand. Retail investment rose by 25% from Q3 2009 with the largest contributor being the hoarding of bars, which increased by 44%.
What is impressive in China’s growing demand for gold is the speed and scale of change. A recent survey indicated that China imported over 209 metric tons of gold in the first ten months of 2010, five times its imports in all of 2009. The World Gold Council expects Chinese demand in 2010 to reach 600 tonnes, just behind India’s 800 tonnes of gold. This would mean that China and India collectively bought about half of total world mine production in 2010.
The World Gold Council and the Industrial and Commercial Bank of China recently announced a strategic partnership to help Chinese investors accumulate gold on a daily, dollar-averaging basis. The minimum investment is one gram of gold a day. The programme was launched in April 2010 and, during the first phase in a few selected cities, over one million accounts have already been opened with this one bank, collectively acquiring over 10 tonnes of gold. Retail investment plays a large and growing part in investment demand. Given the growing affluence among the Chinese and their traditional belief in gold as a store of value, this trend is set to continue.
We believe that an attractive way to capitalise on rising gold prices is to invest in small and midsized gold miners as opposed to the yellow metal itself. For example, a gold mining company producing with a marginal cost of $700/oz, selling at $1,300/oz makes $600/oz profit. Should gold rise to $1,600/oz, a 23% rise, the aforementioned company’s profit would rise by 50% to $900/oz. This rise in profitability would drive the re-rating of this company’s shares. Even if gold prices remain at current levels, there are many opportunities for the re-rating of junior gold mining companies’ shares. In particular, those with significant reserves in the ground, growth in cashflow, little or no debt and competent management teams that continue to explore and add to their reserve base. These companies should outperform both the market and the sector.
There are a number of arguments in favour of investing in smaller capitalisation companies. Smaller companies tend to focus on just a few mining assets which makes it easier for experienced investors to identify outstanding value. Junior gold mining companies are less researched and, as they develop successfully, new investors are encouraged to recognise the real value of their projects. It is also much easier for a smaller company’s share price to double or treble than that of a larger one, and they are also more likely to be taken over as the majors try to add to their reserves. As smaller companies tend to explore more actively in their areas of specialisation, new discoveries can have disproportionate effects on their valuations.
Careful stock picking is important when investing in gold mining shares; this will help avoid issues such as unforeseen increases in operating costs. Important considerations when selecting companies in which to invest include cash flow, the potential for future discoveries and where operations are located. A portfolio approach with appropriate spreading of risk should help mitigate company-specific disappointments. A professionally run, specialised gold mining fund can be a useful allocation tool for investors who do not have the time or the resources to manage such a portfolio.
About Sector Investments
Sector Investment Managers is an independent resources focused investment management company authorised and regulated by the FSA. It advises three open-ended fund products, Junior Gold, the Junior Oils Trust and the Junior Energy Fund, as well as providing advice and management for segregated accounts. Angelos Damaskos founded Sector Investment Managers in 2004 to provide investors with diversified access to the super-cycle in energy and commodities. www.sectorinvestments.com.
RISK WARNING:
This material is directed only at persons in the UK and is not an offer or invitation to buy or sell securities. The fund invests in smaller companies some of which are listed on the Alternative Investment Market which may carry a higher degree of risk. The shares of smaller companies may be less liquid and more volatile over shorter term periods. Changes in exchange rates between currencies may cause the value of investments to diminish or increase. Opinion expressed whether in general or both on the performance of individual securities and in a wider economic context represents the views of Sector Investment Managers Ltd at the time of preparation based on SIM’s internal analysis which may have not been verified by independent sources. They are subject to change and should not be interpreted as investment advice. Before making an investment in the fund, it is important that you read the Simplified Prospectus which is available free by visiting the websites above. Sector Investment Managers Ltd and Marlborough Fund Managers Ltd are authorised and regulated by the Financial Services Authority.
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