Mining and gold ETFs and shares worth a bite

With production capacity drastically slashed and inventories running low among gold and mining producers, it’s the view of the US investment firm, BlackRock that investors might do well to include mining stocks or exchange traded funds (ETFs) in their investment portfolios.

Evy Hambro, the managing director of BlackRock's US$5.2 billion World Mining Fund noted out that most mining equities are now close to record lows after falling by more than 50% last year.

The unprecedented decline was the result of forced selling by investors and speculators needing liquidity during last year's massive markets rout as well as a near-absence of physical demand for commodities amid the current global economic slump.

He pointed out however that the quick responses by commodities producers through drastic cutbacks in production and rationalisation within the sector might have sown the seeds for the next bull market in mining equities.

"Producers have acted quickly to address the change in he demand and supply equation by slashing production – nickel for instance by 20%; aluminium 17%; ferrochrome 75% – and reducing capital expenditure by two thirds to put themselves in a stronger position once demand picks up."

Noted Mr Hambro, "The best time to pick up mining equities is when the capital expenditure is at its lowest as was the case during 1993-94 and in 2001, which were outstanding entry points."

"We have just seen one of the biggest cut in capital expenditure with US$50 billion taken out of the natural resources space either though suspension or delays in new investment. So we are close to the ideal entry point as we are also starting to see the green shoots of recovery with signs of inventories re-stocking and other activities being reactivated including mergers & acquisitions."

He added that while valuations of mining stocks are at an all-time low, earnings growth are likely to rebound due to the recovery in commodities prices as well as declines in production costs for industrial metals. "We will see that trend of recovering earnings accelerating in the second quarter this year. We are cautiously optimistic that we have seen the worst"

Further signs of the longer-term attraction of mining assets, said Mr Hambro, can be found in the efforts by Chinese enterprises to accumulate physical quantities of metals such as aluminium and copper, as well as trying to pick up bigger stakes in foreign producers such as Rio Tinto.

"The reality is that the world needs metal now and will need more in the future. With mining resources been gradually depleted even as new capital investments are being slashed – what is going to happen in future when demand recovers is that there won't be enough supplies to go around."

Going for Gold

Meanwhile, Mr Hambro added that it's BlackRock's view that bullion prices would generally follow a steady upward trend in the next three to five years.

Current demand for the physical metal has been so strong that both the US and Australian mint in Perth have suspended sales of gold coins and bars due to an inability to cope with demand.

Sales from central banks all over the world have also been declining over the past few years and is expected to be the lowest in 2009.

"In fact, some central banks are now buying. Good luck to you if you can find a gold bar for sale in Russia as the central bank there has been buying them up as soon as the producers get them out the ground," said Mr Hambro.

He added that the supply of gold has continued to fall despite rising prices with production falling in the foreseeable future.

"Gold production was down 4% last year and may fall further in 2009. This is partly due to the lack of exploration success by an industry, which discovered 15 million ounces of gold last year, compared with production of 80 million ounces"

The price of the precious metal in his opinion might find further support from possible devaluation in global currencies, as well as the likely longer-term possibility of a weaker US dollar, especially with the US Fed printing more money to re-inflate the American economy.

Mr Hambro pointed out that with the greenback often regarded as a safe haven, the usual tendency is for a negative correlation between the value of gold and the US dollar.

"Usually the price of gold will fall when the US dollar picks up. The thing that encourages me is the fact gold has been as strong as it has been when the dollar has been strong. If the dollar weakens, we could see an explosive move (in gold prices)."

"Gold today enjoys its time-honoured role as a physical store of wealth when confidence in other assets – private or governmental – is in doubt. The reservoir of investors seeking to protect their capital is gigantic – US$3.85 trillion is in US money market funds, yet only US$47 billion is invested in gold via exchange traded funds (ETFs)," he added.

It’s BlackRock's view that investors who are seeking exposure to gold should consider gold ETFs and shares, as the values of these instruments tend to rise proportionally more than the price of the metal itself.

Mr Hambro pointed out that gold shares – unlike ETFs – have the added advantage of "paying dividends as well as benefiting from news of new discoveries and production growth from acquisitions if you want to have a bit more excitement of owning gold."

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