Gold fund strategy for the decade - Building on Brown's Bottom

Changes in the world gold production scenario have, of necessity, meant that to stay ahead of the game, gold fund managers have had to make major strategy changes.

ZURICH - 

Speaking at a luncheon at the Denver Gold Group's European Gold Forum in Zurich, Graham Birch, Managing Director of Black Rock Investment Managers, which administers the Merrill Lynch Gold and General Fund, apprised the audience of the changing strategies in the gold equities market that has kept the fund well ahead of  the gold price performance and the FT Gold Mines Index over the past few years.

From 2000 to 2002 - a time coined by Birch as Brown's Bottom - the gold price reached its recent nadir.  The epithet of Brown's Bottom was due to the decision at that time by Britain's ‘cautious' Chancellor Gordon Brown, whose spin doctors have promoted him as some kind of ‘financial genius', to sell off a good proportion of  Britain's gold reserves.  This timing exactly mirrored the gold price ‘bottom' and the subsequent gold bull market, which has so far lasted almost exactly five years, began almost from the exact date that the UK gold sales programme finished.  The gold price has risen by 167 percent since that date, losing Britain some £2 billion which makes the Gordon Brown ‘financial genius' spin somewhat tarnished.

Birch is undoubtedly bullish on gold - as were most other speakers at the conference who felt that gold is only partially into its latest bull run.  He has also had the opportunity to base his group's investment decisions upon these views with some success.  However, as he pointed out - in this relatively short space of time the gold supply situation has changed dramatically, and his funds' investment strategies have had to move accordingly.

He also pointed out that Gordon Brown in his gold sale decision was not the first British Labour Party minister to sell gold just as the market took off.  Harold Wilson's earlier administration also sold off some of the country's gold reserves just prior to the boom which took gold to record price levels in the 1970s!

As Birch pointed out in his presentation, the gold production scenario has changed dramatically since the start of the current millennium.  The world's historic top four gold producers, South Africa, USA, Canada and Australia have all shed production.  Gold output in South Africa has fallen by 36 percent between 2000 and 2006, that in the US and Canada combined has dropped back 30 percent and Australia by 18 percent.  Indeed Australia has been overtaken as the world's third largest producer by China.

What this has meant is that Birch's Group's gold fund investment pattern has also changed dramatically to take account in the changes in source.  He and his colleagues running the Merrill Lynch fund have cut their exposure in the US and Canada by 31 percent, South Africa by 41 percent and Australia by 21 percent.  On the plus side they have boosted exposure to China by 10.4 percent and Russia up to 8 percent, as well as investing in companies operating in other ‘new' gold producing countries as well.  But not only has the regional investment pattern changed, the fund has also put small, but significant, percentages of the fund's money into other precious metals - notably platinum and also some into copper-gold miners.  For some purists this dilution of gold content is almost heresy - but Birch has only to point to the fund's performance against the gold price and the FT gold mines index to have most of his investors remain happy with such changes.

Overall too, Birch pointed out that world gold production has been falling for the past five years and he feels it will continue to fall in 2007, despite the latest GFMS figures suggesting a small increase.  Birch feels GFMS is too ready to believe what the producers say they will produce this year.  Interestingly, Martin Murenbeeld at a breakfast presentation at the same event, also pointed out that his financial model, which has been remarkably accurate in recent years, also showed a continuing decline in world gold output.

So what other kinds of changes has the Merrill Lynch fund made.  Diversification has not only been regional, but in numbers of companies held.  In 2000, the fund had 37 holdings and £72 million of assets (of which 22 of the companies held are still in existence and 13 have been taken over and two became insolvent).  In 2007 - the number of stocks held had increased to 73 with a total asset value of £907 million.

And which stocks?  The fund's biggest individual holdings are, in order, Lihir Gold, Gold Fields, Zijin Mining, Barrick Gold, Newmont Mining, Impala Platinum, Newcrest, Industrias Penoles (the only silver stock Birch feels worth holding), Anglogold Ashanti and Aquarius Platinum.

So where does Birch feel we are going from here?  He predicts a continuing strong gold market as the ‘big four' countries' gold output continues to fall off, and world gold output continues to decline overall.  He predicts further environmental and political roadblocks affecting production ahead with Latin American and FSU countries particularly vulnerable with African politics remaining the "usual mix of good and bad."

This increases the pressure to diversify geographically; puts a larger premium on growth; a greater need to allay risk through the production of other metals; and also on a growing focus on exploration activity.

As far as the future of the Merrill Lynch gold funds is concerned, Birch means to stay ahead of the trends.  He reckons there will be continuing emphasis on emerging gold producing regions - he is particularly keen on China - and will be keen to focus on production from mining-friendly nations like Mexico and Brazil.

He also hopes and feels that at some stage a gold/precious metals Rio Tinto type company will appear.  According to Birch there is no comparison between the consistent performance of Rio Tinto, with its diverse range of commodities, with that of the purer gold producers like Newmont or Barrick in terms of investment returns.  His view is that a precious metals focused company should emerge which diversifies its mining activity into gold, platinum, silver and perhaps diamonds also, which would give a much superior risk/return ratio.

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