Local gold miners seen to shine this year

After a stellar run last year, gold is still seen performing well this year as lingering global economic uncertainties tend to lure investors into precious metals, in turn benefiting Philippine mining stocks.

Global investment bank Bank of America Merrill Lynch, in its latest monthly commodity reported dated January 3, said that after an “eventful” 2011, most commodities ended down modestly last year with the exception of gold.

“Gold was a stellar performer in 2011, outpacing many commodities and all major asset classes, including US treasuries and US equities, and posting a positive return for the 11th year running,” the report said.

The report estimated that returns on gold amounted to 9.7 percent last year mainly due to higher demand arising from continued loose monetary policy and reserve diversification into gold among central banks.

Based on the London Gold Fix, a global benchmark for pricing majority of gold products, gold was priced at $1,574.50 an ounce at the end of 2011.  Buoyant gold prices have, in turn, helped propel the Philippine mining index by 68.5 percent last year, outperforming all other sectoral indices.

On the other hand, the BofA Merrill Lynch report noted that energy prices had a good run-up in the first half of 2011 mainly on the back of a crude oil supply shock, but finished only slightly up for the year. Meanwhile, it pointed out that base metals had declined 22 percent on continued economic headwind and slowing global growth.

If one is worried about sovereign default, quantitative easing by the US Federal Reserve or stagflation, the BofA Merrill Lynch report said gold would be the best play this year. “For those who believe the gloom and doom is overdone, Brent oil and corn present upside potential,” the research said.

Veteran fund manager Gus Cosio, president of First Metro Asset Management Inc., agreed that an upbeat trading of gold would bode well for mining stocks but noted that investing directly in mining equities would provide better value than investing in gold itself.

Cosio explained that people can invest in gold in three ways, first of which is to buy physical gold, but this is very inconvenient and costly.  Other ways would be to invest in physical gold contracts and gold futures, but he said these were quite volatile and tedious.

“The risk can’t be handled by a normal investor,” Cosio said.

But in mining equities, Cosio said the investor would be investing in the margin between the commodity price and production price. So when commodity prices are stable, the mining companies with the high value and low production cost benefit the most, Cosio said.

“Even if the price of gold and copper comes down, what’s important is the margin in production,” he said.

Cosio said that when future prices were high, mining companies have the option to sell in the futures than in the sport market. “Then when the production comes out, they will buy back their futures contract and if the gold price is lower, they would have already earned on the futures side,” he said.

When prices are low, he said the mining firms could earn from selling gold options and thus earn from the premium. “And they’re not at risk of losing because they have the physical gold behind them,” Cosio said.

“That’s why it’s more profitable to make a play on mining shares than pure commodities,” he said.

“Our conviction is mining will continue to be a good driver of interest in this coming year simply because not all mining companies are able to produce at comfortable margins so we choose the mining companies that produce at comfortable margins, be it gold, copper or nickel,” he said.