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Investec fund bets on small gold producers

Small and medium-sized gold producers with rising output which hasn’t been hedged are bid targets and a better bet than large firms in the sector, Investec Asset Management says.

Daniel Sacks, a portfolio manager, at Investec told Reuters, that small producers will gain more from record high bullion prices than large ones because they haven’t sold their future output at prices well below current levels. “We look for companies with no hedged production, rising volumes and good cost containment, whose earnings should therefore rise by more than gold,” Sacks said. “Gold majors like Newmont have battled to replace mined reserves and have acquired junior producers and explorers to make up for a lack of exploration success.”

Apart from New York-listed Newmont Mining, Sacks also expects other major gold producers such as South African gold miners Anglogold Ashanti, Gold Fields and Harmony Gold to underperform.  His preference, is for smaller companies like Toronto-listed Kinross Gold, London-listed Randgold Resources and Australia’s Lihir Gold. “The gold market is still relatively diverse and we like companies which could be targets for majors,” Sacks said. “(Canada’s) Great Basin Gold is our preferred junior. It has two mines in development, one in the Witwatersrand, and the other in Nevada.” Great Basin is a potential target for Newmont, he said.

 
OPPORTUNITY COSTS

Spot gold hit a record high of $1,030.80 a troy ounce on March 17. It was trading at around $950 on Thursday, about 50% above the levels seen at the beginning of last year. Financial uncertainty triggered by the problems in the US subprime mortgage sector has reinforced gold’s status as a refuge for investors fleeing equity markets. Also fuelling the rise has been the tumbling dollar, partly because of aggressive rate cuts by the US Federal Reserve to shore up growth and confidence, which makes commodities cheaper for holders of other currencies. “A need to restore the health of global bank balance sheets is likely to result in a sustained period of very low interest rates,” Sacks said.

Benchmark US rates have been cut by 1.25% so far this year, to 2.25%. Economists expect rates to fall further below 2.0%, possibly to 1.0%. Record high oil prices have also boosted gold’s appeal as an inflation-hedge. “The last time global food and energy prices kicked off together was during the early 1970s and that was the last period of sustained cost-push inflation in the West,” Sacks said. Also weighing on the dollar are negative real US interest rates -- the difference between interest rates and inflation currently at around 4% year-on-year. “Gold is non-interest bearing and does not pay a dividend. Therefore, when interest rates are low or especially when they are negative in real terms, the opportunity cost of owning gold is minimal,” Sacks said.

Historically high gold prices would normally trigger a supply side response. But that is unlikely this time because major producers in South Africa, North America and Australia are having to dig deeper at higher costs. “We don’t see supply upsetting the market like it did in the 1980s,” Sacks said. "Despite the fact that the gold price has risen 200% since the beginning of the decade, the supply of gold has remained static to declining."

Investec’s gold fund has about $300 million under management. It returned more than 30% last year and is up more than 18% year-to-date. (Reuters)