Precious metals mutual fund managers report that mining companies, meanwhile, are cash rich and earnings are growing at double-digit rates. The reason: It costs about $500 per ounce for major producers to pull ore out of the ground. Every 1% increase in the price of gold typically results in a 3% increase in the price of mining stocks because of the operating leverage.
Rachel Benepe, manager of the First Eagle Gold Fund, sticks with the largest mining companies, those with long-life mines. She seeks proven reserves and operations in regions where mining is widely accepted and where the political environment is stable. For diversification, she keeps about 25% in gold bullion.
"Large-cap producers like Newmont Mining and AngloGold are all generating tremendous cash flows and have good business plans," Benepe says. "Their costs are contained and the price of the product is going up."
The fund's largest holdings, on average, are growing earnings at 14%. "Gold is currently playing the role of substitute currency," she says. "We see the fiat currency system facing a number of challenges. The status of the U.S. dollar as the world's reserve currency is suspect. The euro is facing its most critical challenge in its ten-year history. The yen also lacks appeal."
Benepe adds that the above-ground supply of gold is limited and the quality of newly mined ore isn't as good as it used to be. She does not forecast the price of gold, but instead "evaluates the cost on a spot basis versus alternatives." She will increase the fund's holdings in gold bullion to up to 25% if she sees that bullion is cheaper to own than mining stocks.
Although the valuations of platinum mining companies declined last quarter, Thomas Winmill, manager of the Midas Fund, believes that both platinum and silver will outperform gold over the next several months. The reason: The industrial use of both metals will rise with Asian buying and an improving U.S. economy.
The Midas Fund invests in gold, silver and platinum mines, as well as other natural resources and commodities such as iron, aluminum, copper, uranium, titanium, coal, oil, natural gas and forest products. At this writing, the bulk of the fund was invested in gold, silver and platinum mining companies. The fund's five largest holdings, which make up 25% of the portfolio, include Newmont Mining, Barrick Gold, Centerra Gold, Northgate Minerals and Aquarius Platinum. The fund had about 16% of its assets in other natural resources companies.
Other money managers say we are experiencing a gold bubble because of the fears about government deficits and inflation. When the bubble bursts, investors could experience massive losses in bullion and mining stocks.
Bob Wiedemer, managing partner of the Foresight Group, an advisory firm in Washington, D.C., sees gold as a long-term bubble that could last another ten years before bursting. "I remain very bullish on gold long term," he says. "It will reach $5,000. But short term, I am concerned about a pullback in commodities prices due to a popping of the Chinese government stimulus and real estate bubbles. A 30% pullback in commodities could take gold with it-down 10% or more."
He recommends that advisors avoid jumping in and out of gold given its extreme volatility. They should instead sell to capture some profits or use put options to hedge their positions.