Mark Dampier: Gold will still shine despite recent price fall

The Analyst

The price of gold has fallen about 10 per cent since setting new highs around Christmas. Some commentators are convinced that we are witnessing the start of a sustained downtrend, but I don't see how circumstances have changed. Given the run-up in gold, it was always likely to enter a period of profit-taking, and with real interest rates in the West at historic lows and the US printing presses still rolling (albeit in electronic form) I think it's far too early to write off gold.

As you would expect, a number of gold-related funds have performed extremely well as a result of buoyant bullion prices. One in particular is Smith and Williamson Global Gold and Resources, which is managed by AGF, a Canadian company that owns a minority stake in Smith and Williamson. The fund managers, Ani Markova and Bob Lyon, still believe we are in a structural bull market for gold. Of course you would expect them to say that, but interestingly they point out that very few private investors (in the US and Canada at least) have bought gold in the same way that institutional investors have. A sign, they believe, that there could be much more to come in gold's bull run.

The amount of money they manage is relatively small compared to their peers, allowing them to invest a larger proportion of assets in smaller companies. This can give them an edge over larger rivals as many of the small producers are more sensitive to movements in the gold price, though it means the fund can be quite volatile. The managers also feel they have an advantage being based in Toronto, as many junior gold stocks are listed on the Toronto Stock Exchange. Not only are they close to the trading action, but they can often meet with company management at an early stage, follow the firm through its development, and gain a thorough understanding of the quality of the reserves and the costs involved in extraction.

This information is vital in terms of making an investment decision. Although the gold price has been rising, so has the cost of various other commodities, so the process of building a mine and getting metal out of the ground is becoming more expensive, eating into any additional profit from a high gold price. This is why the team place emphasis on assessing the quality of the company management and visiting the mines themselves.

Ani Markova and Bob Lyon are convinced that the underlying market for gold is very strong. Despite a 400 per cent increase in gold demand in the past 10 years, supply remains flat. The rising price has dampened demand for jewellery, but investment demand has more than made up for this as investors increasingly seek an inflation hedge and a store of value that can't be undermined by money printing. Many central banks too seem keen to add to their reserves, though one country is noticeable by its very low levels: China. The Chinese have just 1.6 per cent of their foreign exchange reserves in gold. If the government wanted to have a similar proportion to the US, it would absorb the entire world gold production for the next three years.

This is an interesting resources fund, which has taken full advantage of its ability to invest in smaller gold and other mining companies. If you already hold one of the larger funds, such as BlackRock Gold & General, you might consider buying this to go alongside it as part of your portfolio. I certainly think it is worth having some gold exposure in today's economic environment. The global economy still has plenty of problems, and sovereign debt issues will surely resurface at some point over the next 18 months, and gold could benefit from any flight to safety this causes. I still think gold and gold funds are worth buying on signs of weakness, and now could be a reasonable time.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent