Gold fund glitters in dull market
>>Merrill Lynch Gold & General has handed its growing army of investors a more then useful return of 76.7 per cent over the last 12 months, trouncing the rest of the UK's 1,750 unit trusts and oeics, which have mustered an average 12-month return of minus 13.1 per cent.<<
Steve Johnson
FT.com site; Sep 17, 2002
LONDON (FT Investor) - All that glitters may not be gold, but the UK's only specialist gold fund has certainly enjoyed a glittering year.
Merrill Lynch Gold & General has handed its growing army of investors a more then useful return of 76.7 per cent over the last 12 months, trouncing the rest of the UK's 1,750 unit trusts and oeics, which have mustered an average 12-month return of minus 13.1 per cent.
Clearly the Merrill fund's strong run may falter if the global gold price were to drop.
But with international tension mounting amid the increasing likelihood of a US-led attack on Iraq, the precious metal is once again fulfilling its traditional role as a safe haven: from $276 an ounce on January 1, gold is now fetching $322 an ounce, a rise of 17 per cent.
Graham Birch, manager of the Merrill fund since 1999, bristles at the idea of the ý184m fund being a safe option in troubled times, however.
Speculation
"Gold bullion is a safe haven, gold equities are a geared play on gold and are actually a speculation," he says.
"Most of the people who buy our fund are not buying it as a safe haven, they are buying it because they believe they are going to make some money out of it."
Merrill Gold & General invests in the shares of gold producers, sprinkled with a handful of platinum, diamond and silver miners. Mr Birch argues that these gold equities are three-to-five times geared plays on the gold bullion price.
For instance, if the cost of gold production from a given mine is $220 an ounce, and the gold price is $300 an ounce, the profit margin is $80 an ounce. If gold bullion was to rise just 10 per cent to $330 an ounce, the profit margin would jump 37.5 per cent to $110/ounce.
This leverage explains why the FT Gold Mines Index, a global measure of the industry's stocks, has risen 48 per cent so far this year, virtually three times as fast as the gold price.
Leveraged exposure
An investor could get the same leveraged exposure to the gold price by buying a call option on the future price. Perhaps not surprisingly, Mr Birch recommends the equity option.
"An option has a time limit on it. It decays in value if the price has not risen, and may well be worthless. With this fund you will never lose all your money," he says.
According to Mr Birch, the fund attracts two types of investors, those seeking diversification in their portfolio and those with a strong belief that the gold price will rise.
Perhaps surprisingly, the manager does not explicitly attempt to forecast the future price of gold in constructing his portfolio. But he does have a view.
"My private view that it will probably go a lot higher. The gold price today is by no means excessively high. It is below the average of the last 20 years. I think we are in for a period of prolonged uncertainty," he says.
"If tension reduces, people won't feel so much use for assets like gold and the fund will perform poorly in that environment. But over a long period of time we will do well, even if the gold price is subdued, by focussing on companies that are good investments."
Return of 585%
As a demonstration of this, the fund has returned 585 per cent over the last decade, while the gold price has actually fallen by 6 per cent.
"There are times when assets in this sector are literally given away, others when they are ridiculously cheap," says Mr Birch.
Of Gold Fields , his largest holding, he says: "Two or three years ago it could be bought for the equivalent of less than $20 an ounce for reserves in the ground."
Gold Fields is among the 41 per cent of the portfolio that is invested in South African-based stocks - a market that was recently hit by the release of a draft mining charter drawn up by the nation's department of Minerals and Energy calling for a substantial transfer of mining assets to black ownership.
Not good news
"We were quite upset by the draft mines charter and took the view that it was not good news," Mr Birch says understatedly. "Subsequently the government has backed away and things have calmed down a bit."
As a result of the uncertainty, Mr Birch said he would be looking for higher returns from South African stocks to compensate. But he argues that Gold Fields, as well as other leading South African holdings such as AngloGold and Harmony Gold , have all diversified their operations into other countries.
Although North America and Australia (at 28 and 11 per cent respectively) are the next largest regions in Gold & General, there is a strong overall emerging markets bias. Despite the uncertainty this can bring, as South Africa has vividly shown, Mr Birch sees this as a positive.
Licence to print money
"These economies tend to have weak currencies. This is quite a good thing for a gold mine, which is a machine that prints hard currency. In a weak currency area profits are greater, as costs are in the local currency and income is in US dollars."
When it comes to selecting individual stocks, undue risk aversion by a particular company can be a turn-off for Mr Birch.
Some mining groups hedge their exposure to the gold price by selling gold futures in the derivatives market. Barrick Gold is one stock playing that game at present.
"We don't have much Barrick in the portfolio because we feel that the hedging has reduced the effectiveness of the company, as we take the view that the gold price is too low. We prefer Gold Fields and Harmony because they don't have any hedging," the manager says.
Sole survivor
Merrill Gold & General is the UK's sole-surviving specialist gold fund, with the 20-year bear market in the precious metal seeing off its rivals.
Its last remaining direct competitor, the M&G Gold fund, was merged into the M&G Global Basics fund , which admittedly boasts Lihir Gold as its second largest holding.
Other funds with some exposure to gold mining include JPMF Natural Resources and Britannic Global Resources . See Commodities funds offer safety
Amongst investment trusts, Mr Birch also manages the Merrill Lynch World Mining Trust , which is 30 per cent exposed to gold, alongside base metals, platinum and industrial minerals.
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