Gold mining funds, which invest in shares of mining companies globally, has underperformed returns of that of gold over the past three years. In an interview with Chirag Madia and Muthukumar K, Pankaj Sharma, EVP, head of business development & risk management at DSP BlackRock Mutual Fund tells that widespread selloff in equity markets has affected performance of gold equities irrespective of their strong underlying. And the parent BGF World Gold Fund that has been around for more than 15 years has strongly outperformed gold returns. Excerpts:
Where are the gold prices headed?
Current gold prices are being led by investment demand as investors fret about currency market uncertainty and global economic imbalances. While we are likely to see volatility and various policy responses in the near term, any firm long-term resolution on these issues is unlikely to be enacted in the near future and the underlying issue of major economies having large debt burden remain. Many investment banks are upgrading their price forecasts for gold for the coming 18 months. For example, Barclays recently announced an average spot gold price forecast of $1,624/ oz for 2011 and $2,000/oz for 2012.
How do you see earnings growth of gold companies?
Gold equities appear to be pricing in the average gold price for the year till date and so significant upside potential (given the current gold price, analyst expectations and margin growth potential) may be in place. Examining the case for margin growth in the industry will help illustrate this point. In 2010 the realised average gold price for the year by the industry was above $1,200/oz in 2010 and the average cash costs across the industry were a little higher than $ 500/oz. So far in 2011, gold has averaged close to $1,500/oz; so even if currency fluctuations, labour and raw materials inflation cause costs to rise by 10-15% this year, the companies look set to expand margins, as is already being reflected by record cashflow generation in the past.
Your sectoral allocation shows 12-15% investment in other precious metals like silver and platinum, Any reasons?
The natural resources team has maintained this exposure to silver and platinum miners over the last couple of years as a tactical call within the precious metals space. Silver has continued to be used by investors as a high beta proxy for the rising gold price. The precious metal has also benefited from the improving demand from the solar industry.
FTSE Gold Mine Index tends to under-perform during the gold bull run. Is it true?
We would not completely agree with the above statement. There has been strong directional correlation among gold and equities. If gold prices rise, it is the gold miner who stands to benefit and that gets reflected in the stock price. However there have been times when we have such divergences in the price of gold and gold equities, but these have been very short term in nature.In the recent gold price rally, such divergence can be attributed to the widespread sell off in equity markets as a risk aversion trade and even gold equities irrespective of their strong underlying getting engulfed in the same.
Historically, what are the trends when gold prices go down?
There has been a strong directional correlation among gold and equities and the same applies to a falling gold prices scenario. However the gold miner has the option of hedging against falling gold prices and reducing the downside.
DSP BlackRock World Gold Fund has not outperformed Gold ETFs returns over short as well as long term. Any reason?
The parent BGF World Gold Fund which has been around for more than 15 years has strongly outperformed vis-a-vis gold. The short term divergence in performance of gold and gold equities has resulted in a short term underperformance of the fund, which we believe are short lived and therefore presents a great value proposition for investors looking to invest in the category. One needs to understand that the period referred includes 2008, when we saw widespread sell off in equity markets as a risk aversion trade and even gold equities irrespective of their strong underlying bearing the brunt. Thus, resulting in a short term underperformance. Moreover. gold equities have more than trebled from the lows of 2008 while gold has not.
Is hedging by gold miners the reason whytheir profits are not in line with the gold prices?
Most gold miners have been winding up their hedging positions over the last few years, which were an indication of their conviction in an upward trend in gold prices. In the last two years, Barrick has eliminated its gold hedge position of 9.5 million oz at a weighted average gold price of about $ 930 per oz.
Barrick also went to press claiming the company was fully exposed gold price upmoves. However, on the decision of hedging by gold miners, we believe being in the industry the miners are in the best positions to forecast the price of gold and the best realisable value for their produce.
