Gold will still gleam next year but some miners will outshine others

Frankincense and myrrh may have faded from view, but gold has retained its allure. Never more so than this year, when the yellow metal capped a decade-long rally to reach a $1,216-an-ounce high at the start of this month. Even after retracing some of those gains in recent weeks, it has still risen by one quarter since January — and nearly fourfold since the turn of the century.

Evidence of its popularity abounds. Last month the US Mint suspended sales of its popular American Eagle 1oz bullion coins after demand from retail investors stripped its vaults bare; John Paulson, the American hedge fund manager who earned billions from betting on the collapse of the US sub-prime mortgage market, has launched a new gold fund seeded with $250 million of his own cash; and the gold holdings of exchange-traded funds (ETFs), the listed vehicles that provide investors with direct exposure to the metal, are up 48 per cent on the year to a record 1,762 tonnes. At that level, ETF holdings now exceed the national reserves of all but four of the world’s biggest gold-owning countries.

This enthusiasm for gold is not fuelled solely by demand. There is talk of supply constraints, too. Last month, Aaron Regent, the president of Canada’s Barrick Gold, the world’s biggest producer, told a conference in London that there were signs that the planet had reached “peak gold” — the point at which the maximum rate of extraction of a finite reserve is passed. In confirmation of that bullishness, Barrick spent October and November winding down the three million ounces held on its fixed-price hedge book, a move that will allow the company to take full advantage of future rises in gold prices.

For followers of UK equities, the most tangible sign of this rally has been the rise to prominence of London’s listed goldminers. Shares in Randgold Resources, its biggest pure gold play, are up 67 per cent since January, valuing the company at nearly £5 billion — bigger than Next, Legal & General or Cable & Wireless. The Russia-focused Petropavlosk, formerly Peter Hambro Mining, has done even better — up 173 per cent, such that this month it narrowly missed out on promotion to the FTSE 100 index. Elsewhere, Centamin Egypt — up 183 per cent — signalled its maturity last month by moving to the official list after eight years on AIM, where it had been one of the biggest constituents.

The bulls’ case is threefold. First, the world’s central banks were big net buyers of gold in the second half of this year (see chart) — a move spearheaded by emerging markets, most notably the Reserve Bank of India, which recently bought 200 million tonnes from the International Monetary Fund as part of its strategy of diversifying its reserves. Advocates of higher prices find such buying reminiscent of the late 1960s, when European central banks, led by France, began to convert their dollars into gold — not so much a vote of confidence in gold, but a loss of confidence in the dollar. Equally, that transaction has served to tighten supply, effectively halving the net amount of gold approved for sale by the IMF. In rejoinder, gold bears suggest that central banks have a relatively poor reputation as commodity investors — such that India’s buying could signal the top of the market in the same way that Britain’s selling signalled the bottom in 1999.

Second, American monetary policy remains supportive to gold. Research by Goldman has found a strong relationship between real interest rates and gold prices. On the expectation that the Federal Reserve is likely to keep its short-term interest rate target near to zero through to 2011, the bank believes that gold prices should be underpinned at existing levels.

Third, continued buying by ETFs is predicted to provide a substantial prop to future prices — and, at the very least, offset the effect of any central bank selling.

So where to turn? Of large-cap London-listed precious metal plays, Goldman favours Hochschild Mining — ( who own 20 million shares of Lakeshore Gold, LSG-T) - the Latin American miner better known as a silver producer.

In the wake of higher gold and silver prices, and the one-off costs related to October’s $250 million fundraising, the bank yesterday set a 468p 12-month price target — implying a gain of more than 40 per cent from current levels. In contrast, Goldman has turned more cautious on Randgold, removing the shares from its “buy” list.

It concedes that the African producer has the strongest growth prospects of any of its peer group. Next year’s expected start-up of its Tongon mine in the Ivory Coast, followed by its three longer-dated projects in Mali, Senegal and the Democratic Republic of Congo, should see Randgold’s annual output rise to 1.5 million ounces by the middle of the next decade — making it ninth in the world on present rankings, against sixteenth now.

Goldman also cites Randgold’s favourable production costs, which it expects to fall faster than any of its rivals. However, it thinks that those prospects are priced into the shares — whereas project delays are not.

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