We've been fans of gold for a long time. Real interest rates remain negative in most developed economies, and central banks are itching to print more money. That all points to long-term inflation, which will push the price of gold even higher.
However, while we think it's worth having some physical gold in your portfolio as inflation, there could be an even better way to play the gold price just now: gold miners.
Gold mining stocks have taken a real hammering. With the price of gold trading at around $1,600 an ounce, fund manager Neil Gregson claims on Citywire that many gold miners are now trading at below the value of their assets. Indeed, he points out that gold would have to fall by 25% for share prices to be fair.
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So what's the problem and should you buy in now?
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Gold miners don't deserve the punishment they've had
Don't get us wrong. There are clearly some valid reasons why you should be cautious about gold companies. Many of the major mining companies made a stupid decision a few years ago to hedge their reserves, by selling gold futures (contracts to deliver a certain amount of gold in the future). This locked them out of rising prices.
Also, Asian demand for gold, one of the key drivers of the soaring price, could be hit if China makes its harder to buy gold, or India imposes a rumoured tax on jewellery.
However, in our view these factors have been overplayed. Having learned the downside of selling future production in a rising market the hard way, companies have stopped doing it for new reserves. As Daniel Oliver of Myrmikan Capital points out: "strategic hedging has nearly vanished from the industry".
Of course, the obvious downside is that this will make revenues more volatile. However, it should also mean that the value of the companies' gold reserves should reflect the current price. Some companies, such as Goldcorp, do not hedge at all.
We also think that Asian demand will continue to grow. Indeed, according to the latest data, Chinese demand for gold in the first quarter of this year was 13% higher than it was at the same time last year. Industrial and Commercial Bank of China Ltd thinks that demand will grow by another 10% this year.
Although Beijing would love this to stop, the economic crisis makes it wary of risking the public backlash that tough measures would entail. Similarly in India, any tax on gold or jewellery would be political suicide for the current government in Delhi.
Gold mining companies and funds to buy
In terms of trailing earnings gold mining companies do not seem particularly cheap. However, when one looks at expected earnings, things change dramatically.
For instance, while Goldcorp (NYSE:GG), which we've previously looked at in more detail, has a p/e ratio of nearly 20, its forward p/e falls to below 13. Newcrest Mining (ASX:NCM), is also trading at 12.6 times predicted profits.
At the same time, many shares have fallen quite steeply over the past year, making them a contrarian play. Indeed, Goldcorp has fallen by 18% while Newcrest has gone down by nearly 40%.
Two weeks ago, Simon Popple suggested two other shares that look worth buying. However, if you don't want to look at individual companies, you might want to consider a fund that invests in the sector. One such fund with a strong track record is the Black Rock Gold & General Fund. It has produced a cumulative return of 50% in the last five years. In contrast, comparable specialist sector funds have barely broken even.
