It's the beginning of the new year, but will that mean good news for your investments? By all accounts, 2009 is not going to be very bright. With one exception. Gold. The metal has managed to retain its sheen even through the darkest of times. So it's a smart move to invest in companies that mine gold, isn't it? After all, it would be like investing in the mother lode.
| GOLD vs ETFs | ||
|---|---|---|
| Differentiating Factors | Gold ETF | Gold Funds (Equity) |
| Investment rationale | Invests in gold bullion | Stocks of mining companies |
| Performance drivers | Change in price of gold | Firm's financials, market sentiment |
| Fund management | Passive | Active |
| Risk involved | Low | Moderate to high |
| Correlation to equity markets* | Zero to negative | Positive |
| *The higher the positive correlation, the higher the movement in line with the markets. | ||
Mutual fund houses thought so and launched gold equity funds to invest in companies involved in gold mining and allied activities. These funds were launched because of the popularity of gold exchange traded funds (ETFs), which invest in gold bullion. Sadly, the results have not been the same. Take the DSP Black Rock's World Gold fund, which was launched in August 2007. In the past one year, it has delivered a negative return of 22% compared with a positive return of 25% by the Gold ETF.
This does not mean that gold is losing its sheen. "Investors must understand that gold ETFs and gold equity funds belong to different asset classes," says Lakshmi Iyer, product head, Kotak Mutual Fund. Gold ETFs buy physical gold reserves and the units sold against these reserves are linked directly to the price of gold. Gold equity funds invest in equities and equity-related securities of mining companies, which are susceptible to companyspecific issues, fundamentals of the industry and market sentiments.
Contrary to general perception, the stocks of gold mining firms don't move in tandem with gold prices. Despite a positive annualised return of 16% delivered by the gold index in the past two years, the gold mining index (comprising stocks whose primary activity is mining of gold) delivered a negative return of 4%. "An analysis of the past two years' data shows very low positive correlation between physical gold and the gold mining index," says Iyer.
| THE NUMBER GAME | ||||
|---|---|---|---|---|
During a downturn, ETFs perform much better than gold funds | ||||
| Fund Name | Launch Date | 3 Mth (%) | 6 Mth (%) | 1 Yr (%) |
| DSPBR World Gold Fund | Aug 2007 | -13.6 | -33.2 | -21.7 |
| AIG World Gold Fund | May 2008 | -13.2 | -26.8 | NA |
| Kotak Gold ETF | July 2007 | -0.9 | 3.1 | 25.1 |
| Benchmark Gold ETF | Feb 2007 | 0.9 | 3.1 | 25.2 |
| Nifty | -27.4 | -29.8 | -49.9 | |
| Figures are returns; cut-off date is Dec 21. Source: Valueresearchonline | ||||
The overall cost of production of gold has also gone up, leading to lower profitability for the mining companies. The world's largest gold producer, Barrick Mines, reported a 22% rise in production costs and no growth in net income in the last quarter, despite a rise in gold prices. Another gold miner, Randgold Resources, which constitutes 10% of the AIG Gold fund portfolio and about 5% of the DSP BR World Gold fund, reported an 18% drop in sales and a 60% drop in net income compared with the previous quarter.
The good news: the past month has seen a major reversal. The gold mining index registered an increase of 22% compared with a 2% gain in the gold index. DSP BR World Gold fund and the AIG Gold fund gained 32% and over 40%, respectively. So what has changed? "A weakening dollar and strong fundamentals," says Iyer.
Gold has an inverse relationship with the dollar and a weakening dollar allowed gold to regain its lost strength. The global economy may experience a difficult recession and many analysts are expressing deflationary concerns. "As a form of currency with no liabilities, investment demand for gold may increase with deflationary expectations," says Ruchir Parekh, fund manager, AIG World Gold fund.
Mining companies are expected to benefit from improved operating margins as input costs have come down recently, he adds. Typically, during a boom period, gold companies have an earnings and resources leverage, due to which their profitability tends to increase in a proportion higher than the price of gold. A demand-supply gap will also allow the gold prices to remain high.
So, should you buy gold equity funds? It depends on whether you are looking at capital preservation or growth. "A fund investing in gold companies has to be viewed as an un-correlated asset to other investments such as diversified equity funds or common stocks; it cannot be viewed as an alternative," says Parekh. Investing in a gold equity fund allows access to international diversification. Since gold mining companies are not listed on Indian stock exchanges, the funds offered by Indian AMCs invest in their global funds, which in turn invest in gold mining companies. But remember, even if equity valuations improve, investing in these funds is risky. If your aim is to purely protect your capital, then physical gold or an ETF is your best bet.
