Alternative Outlook

Investors have preferred to invest in physical gold, despite the storage costs, and exchange-traded funds (ETFs), as they are perceived to be less risky than mining companies.

Paul Hissey, an analyst at Goldman Sachs, thinks miners need to do a number of things to entice investors away from gold ETFs, including reducing perceived operational risk; deliver to, and manage market expectations; return cash to shareholders; and replenish resources and reserves.

“However, we will continue to favour exposure to gold companies in the current global financial climate,” said Mr Hissey.

Analysts at Nomura agree, with the Japanese broker initiating coverage of the European gold sector last week with a bullish rating.

“A cash build in the producers should drive growth, spur M&A and push dividends higher,” said Tyler Broda, a mining analyst at Nomura. “This improving outlook has yet to be priced into gold equities, which are trading at historical lows in terms of valuation,” he said. Mr Broda thinks current valuations offer an attractive entry point given market instability. “We see light at the end of the tunnel for gold equity investors.”

Nomura concludes that the gold price should stay elevated with significant upside risks all the way to 2015, which they believe will translate into “a new era for gold producers”. Mr Broda’s top picks are Randgold Resources, African Barrick Gold and Avocet Mining.

However, some are more cautious. Last week, precious metals consultancy GFMS said in an update to its Gold Survey 2012 that the decade-long bull run could come to an end in 2013.

“The report does acknowledge that the gold market is nearing the closing stages of its decade-long bull run and that, once the macroeconomic backdrop changes and investment in gold fades – probably some time next year – a secular retreat in the price will unfurl,” said GFMS.

“A combination of factors will ensure that sufficient demand from investors and to a lesser extent official sector institutions comes into the market for it to clear at higher levels,” added GFMS.

However, Mr Broda is more bullish on demand from the official sector.

“Central bank demand has the potential to grow from virtually nothing to nearly half of the level currently seen by jewellery, which accounts for 40pc of the market,” he said. “This, in conjunction with a potential wider shift in asset allocation to gold, could see gold prices de-anchoring from current levels.”

Net central bank selling has now become net central bank buying, Mr Broda argues. “This shift is important and its impact on the overall market dynamic should not be overlooked.”

There is a general divergence between the levels of gold held by central banks in developed and in emerging markets, according to Nomura’s analysis.

Developed countries’ central banks tend to hold gold from an era where reserves were held both in US dollars and in gold.

Central banks in emerging economies have far lower gold holdings as a percentage of total US dollar reserves, at about 5pc.

“To illustrate the potential impact of this shift in sentiment on the gold market, we have run a scenario analysis that shows total demand for gold would be approximately 3,400 tonnes if the 18 largest non-US/EU, US dollar reserve holders moved their allocation of gold to 10pc of total reserves,” argued Mr Broda.

This figure is excluding China and represents around 75pc of forecast total demand in 2011 of 4,505 tonnes.

China is not included because the analysis suggests that it is relatively unlikely to shift from its current 1.7pc gold allocation in a straightforward manner, “as this would signal a lack of faith in its remaining $3.3 trillion (£2.1 trillion) in US dollar reserves”.

It looks as if 2012 could be brighter for shareholders, who have been both patient and disappointed at the same time. It’s about time that patience was rewarded.

Source : The Telegraph

By Garry White, and Emma Rowley