Gold's glittering returns lure investors

Anthony Fensom | 24 Mar 2016

Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.

Gold is glittering again for investors, with the yellow metal's recent price rise giving ASX-listed miners a radiant glow. With the US Federal Reserve keeping rates steady, negative interest rates in Europe and Japan, and the prospect of increased gold consumption in China and India, the traditional store of value could be set for further gains.

On 17 March, gold rose 2.1 per cent to reach US$1,258 an ounce in New York trading, following news the Fed would likely slow the pace of its planned rate hikes. Lower interest rates benefit the gold price, since the metal becomes more competitive against interest-bearing assets, and with the prospect of slow economic growth in 2016, it could hold its value even longer.

"Gold has been the biggest story of this year," Dan Denbow, a portfolio manager at the USAA Precious Metals and Minerals Fund, told Bloomberg News. "Last summer, people were calling it a barbaric relic and nobody could care less about gold. Now, it's slowly generating more and more buying."

The increased investor interest is shown by the rise in gold held by exchange-traded funds (ETFs) to 1,678 metric tonnes, up 15 per cent as of the end of February, with gold already described as this year's best-performing asset.

Morningstar resources analyst Mathew Hodge suggests gold's shift from a "financial" to a "consumer" commodity should bode well for its future, even if investment demand slows.

"We're forecasting a 4.7 per cent compound annual growth rate (CAGR) for total physical gold demand over the next five years, led by Chinese and Indian jewellery buyers. We expect jewellery to account for two-thirds of gold demand by 2020, up from 50 per cent in the past five years, with the share of purchasing by central banks and ETFs dwindling below 5 per cent," he says.

"While gold supply growth is expected to accelerate, planned projects will be insufficient to meet the demand growth, with an additional 200 tonnes of annual mine supply required by the end of the decade."

According to Hodge, investor gold demand has dropped by 800 tonnes since its 2011 peak, but gold jewellery demand should rise by 1,200 tonnes through 2020, led by the Asian emerging giants, particularly as household buying power increases in China and India.

Meanwhile, central banks have been buying around 400 to 500 tonnes of gold annually in recent years, but this amount is expected to drop to just 100 tonnes annually by the end of the decade.

Morningstar expects the gold price to reach US$1,300 per ounce on a nominal basis by 2020, helped by rising jewellery demand. For 2016, Morgan Stanley is predicting the price will reach US$1,173, while Societe Generale expects US$1,150 and ABN Amro tips US$1,300.

The gold price's recent climb has been particularly attractive in Australian dollar terms, given the depreciation in the local currency against the US dollar.

According to Hodge, Newcrest Mining (NCM) remains his preferred exposure, with the $13-billion behemoth benefitting from a lower Aussie dollar and cheaper mining inputs.

"Newcrest is a little undervalued at the moment compared to our fair value estimate of $18 per share," he says.

"It's had a pretty decent run, but the smaller gold stocks are generally overvalued with a lot of optimism placed into current share prices. Investors shouldn't forget that for the smaller miners, just because they have a mine up and running that doesn't constitute a track record or imply that the next project they do will be as successful.

"These assets have a finite life, they'll need to be replaced eventually and there will be costs and risks associated with that."

Investors seeking exposure to gold can do so through buying physical gold bullion, obtaining shares in gold miners or investing in a gold ETF such as BetaShares Gold Bullion ETF (QAU).

According to BetaShares, adding gold to a portfolio can help increase asset diversification given its low correlation to other assets such as equities, reducing the volatility of returns and lowering downside risk.

While not everyone is convinced of gold's merits--Warren Buffett famously described it as an "unproductive asset"--the prospects for the precious metal appear likely to remain bright for sometime to come.

Morningstar