Buy the miners, not the metal.
"Gold Set to Soar by 20%!" "Beware the Next Gold Crash!" Most days you can find a new investment article with titles such as these, putting either the bull case or the bear case for gold. Confused? So am I.
I buy into the long-term story for gold. But what worries me about the gold price is how volatile it can be and how quickly sentiment can change. I prefer gold miners, which offer upside if the long bull run is sustained, but a softer landing if the bears win.
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The bull case for gold rests on three sources of demand. First, the burgeoning wealth of the East where the middle classes in countries such as China and India buy gold for both cultural and financial reasons. Those two countries are the world's largest markets for physical gold. Culturally, gold jewellery is a significant purchase. And the middle classes have a tendency to use gold as a form of savings and hedge against inflation, with both countries lacking sophisticated savings products.
Western buying is also driven by those who have a fear of the newfound enthusiasm of authorities to print paper money. And finally, demand has been bolstered by central bank buying, particularly from emerging nations. That in turn says something of those authorities' view of the West's reserve currencies.
If you buy into the bull case, there are a multitude of ETFs that enable retail investors to buy and sell readily. For UK investors there are ETFs such as ETFS Physical Gold (LSE: PHAU) or SPDR Gold Shares (LSE: GLD), while US investors have SPDR Gold Trust for example. Gold accounted for three of the top 10 most popular London-listed ETFs last year.
The very popularity of these funds is a central plank of the bear case. Buying gold has become easier and has drawn in a broad swathe of new private investors as investing in gold has become fashionable. But it makes it just as easy to fall out of fashion again.
And gold seems to have lost its safe haven status. As the recent financial turmoil has led markets to oscillate between 'risk on' and 'risk off' appetites, gold has been squeezed out by US Treasuries, UK gilts and similar assets. Perversely, gold now falls on bad economic news and vice versa.
Historically, mining shares are correlated with the gold price, though the correlation is far from perfect. And generally the miners stocks have not kept pace with the bull market in gold. That offers the prospect of further upside as they catch up, with the downside cushion if the yellow metal itself goes into freefall.
The economics of miners is driven by the price of gold and the cost of extraction. Like all natural resource companies the size of their reserves is a factor in valuation, and often as not they operate in difficult or hostile territories, which introduces an additional dimension of risk.
A fine example is Randgold Resources (LSE: RRS), the only FTSE 100 (UKX) gold miner. In March its shares were hit by a coup in Mali, the West African state where two thirds of its production is based. Though the coup has left the north of the country lawless and at the mercy of Taleban insurgents who have desecrated the ancient city of Timbuktu, Randgold's operations in the south and west of the country have largely been unaffected.
That looked like a buying opportunity to me. The one ingredient missing was the sign of directors piling in. That happened in May with CEO Mark Bristow buying £650,000 worth and non-executive Graham Shuttleworth spending £142,000. At 5,825p the shares are up around 10% from their post-coup levels, but are still an attractive buy.
Other interesting gold stocks include Russia-focused Petropavlovsk (LSE: POG) which recently increased 2012 production targets, and Egyptian miner Centamin (LSE: CEY) whose share price has suffered from the political instability in the country. Both could reward patient investors.
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> Tony has shares in Randgold Resources, Petropavlovsk and Centamin. He holds no interest in any of the other companies mentioned.