Investors wanting to play the gold market should consider gold-mining shares, as they have risen far less than the bullion price over the past year. If they decide they want diversified exposure to gold mining, there is one closed-end company which richly deserves their attention, while four others offer a more diluted exposure.

Paul Locke is an investment trust analyst at Canaccord Genuity, with a particular interest in resources, and he contends that gold-mining companies are exceptionally cheap relative to bullion prices. This may be because investors are not convinced gold prices will hold their current level, and gold exchange traded funds may seem easier to sell in a hurry. However, Locke says that many gold-mining companies break even if the bullion price exceeds $400 to $600, so they are currently making huge margins and should continue to do so even if it settles back to around $1,300 an ounce.

‘People do not understand that the gold and silver-mining companies are generating huge cash flow, even though costs such as rubber, explosives and wages have all risen,’ Locke says. He is hoping investors will wake up to the value on offer after mining companies publish their quarterly earnings in mid-October and mid-January.

Admittedly, mining companies are in some ways more risky than bullion, with Algy Cluff, chairman of Cluff Gold, warning that if bullion goes much higher than $1,800 an ounce it may encourage greater wage demands from the miners, or increased resource nationalism by host governments. But with price/earnings ratios often in single figures, the gold mining companies are discounting a lot of problems.

Locke says Golden Prospect Precious Metals offers the purest exposure to gold in the closed-end sector. It is one of three natural resources trusts managed by New City Investment Management, and manager John Wong is building a fantastic performance record. Locke’s enthusiasm is shared by Charlie Long of Singer Capital Markets, who says GPPM offers ‘access to a global gold-mining universe, a very successful investment strategy and superb performance’.

Locke is also positive about the long-term outlook for Geiger Counter, another of New City’s charges, which offsets uranium exposure with some gold.

‘Once people are over the shock of Fukushima, they will realise that China, India and others are still building nuclear reactors,’  he says. ‘But if another nuclear reactor exploded it could  be badly hurt.’ A discount of well over 20 per cent helps to offset doubts on the uranium front.

City Natural Resources High Yield Trust is New City’s largest and most diversified natural resources trust. Canaccord is its broker, and Locke takes pleasure in pointing out that it was the top-performing UK-listed trust in the five years to mid-August. A third of its portfolio is in precious metal-mining companies, which is significantly more than at its larger rival, BlackRock World Mining Trust.

The idiosyncratically managed El Oro is the only other company in the resources sector that has a significant gold exposure.

Glittering performance

Golden Prospect Precious Metals has over 70 per cent in gold-mining companies and the balance mainly in silver. Guernsey-based, it has been managed by New City since September 2008.

Manager John Wong completed the realignment of the portfolio at the end of 2008, since then it has massively outperformed the spot bullion price, the NYSE Gold Bugs index and the leading gold-oriented funds, such as BlackRock Gold & General and Smith & Williamson Global Gold.

Wong favours low-cost producers, as they should be least vulnerable to any weakening in gold prices, and he focuses predominantly on medium to smaller companies as they are better placed to add meaningfully to their resources through new discoveries or to be taken over by the majors.

He says gold and silver-mining companies are exceptionally cheap relative to spot metal prices, which he expects to firm up usefully over the next year or more as central banks around the world continue to worry about holding their reserves in fiat currencies. He geared the trust briefly in July to fund a 5 per cent investment in bullion, which he retains, but has paid off the gearing so that it can be reactivated if there is a serious correction in equity prices. Funds run by Ruffer Investment Management recently held nearly a fifth of GPPM’s shares.

Geiger Counter invests predominantly in companies involved in the uranium industry, but can invest up to 30 per cent in other resource holdings. It currently  has 20 per cent in gold mining companies. Jersey-based, it has been managed by New City since launch in 2006. John Wong succeeded Richard Lockwood as manager in September 2010, having previously worked alongside New City’s founder and natural resources guru.

The trust’s gold holdings are similar to those of GPPM. They can provide some impetus when the uranium price is becalmed and would serve as a backstop if another disaster blighted the nuclear industry.

Nuclear confidence

A promising rally in uranium was severely knocked by the Fukushima disaster. However, Wong’s confidence that the plunge in prices would attract buyers has been vindicated by a flurry of bids for companies such as Bannerman, with Chinese companies among those prepared to pay substantial premiums over the market prices. Noting that the construction of nuclear power stations in China, Russia and India is substantially outstripping decommissioning in other parts of the world, Wong says: ‘If the market continues to grossly undervalue these stocks, corporates and governments will seize the initiative.’

City Natural Resources High Yield Trust targets capital and income growth from a portfolio of mining and resources equities. It is much more diversified than GPPM or Geiger Counter, which should mean it is less volatile, as should its 20 per cent exposure to fixed interest.

Merfyn Roberts succeeded Richard Lockwood as lead manager in September 2010, but Lockwood continues to come to the office most days and works closely with the team. The emphasis is on medium to smaller companies, as they are more focused than their larger counterparts, and more likely to be taken over. Thirty per cent of the portfolio is currently in gold miners, 12 per cent in uranium, and 5 per cent in silver, with John Wong advising on the holdings. The balance includes oil and gas, rare earths, copper, iron ore and palm oil.

The trust has outperformed BlackRock World Mining by a considerable margin over most periods. It is less exposed to industrial metals, and has a higher yield, paid quarterly.

BlackRock World Mining Trust is the largest trust in the natural resources sector. It is managed by Evy Hambro, who is  joint head of BlackRock’s well respected natural resources team, and by Catherine Raw, who joined BlackRock in 2006.

The trust targets total real returns from a worldwide portfolio of mining and metal securities, and has around 40 per cent in large diversified mining companies such as BHP Billiton and Vale. These tend to be particularly vulnerable to changes in market sentiment. Around  20 per cent is in companies devoted to gold, silver, diamond and platinum mining.

The balance is in base metals and industrial minerals, such as coal. The BlackRock trust can invest up to 10 per cent in physical metals, but has not done so for some time as the managers think mining companies offer better value.

El Oro is a little known Guernsey-based company with a volatile record. It has been managed since 1938 by members of the Parish family, which controls 54 per cent of the shares. Robin Parish, its current chairman and manager, travels the world visiting the companies in which he invests. He is approaching 60, has been in virtually sole charge since the late 1990s, and has no obvious successor.    

Parish is apocalyptic about the problems facing the developed world, and worried about mounting stresses in the developing world. He views natural resources as attractive stores of value, so 27 per cent of the portfolio is invested in gold mining shares, and 6 per cent in precious metals and minerals . ‘Other’ materials and energy each account for 12 per cent, and 5 per cent is in agricultural products such as palm oil, rice and cattle ranching. The balance includes pubs, utilities and floor covering companies.

The board hopes dividend increases will encourage more support, but gearing of over 20 per cent means setbacks as well as gains will be exaggerated.

Top gold-mining investment companies