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Marketocracy: Managers Bet on Gold
01/24/2003 12:00 am EST
Marketocracy is an online system designed to allow individuals to create and monitor virtual mutual fund portfolios. Some 65,000 people compete on this site to be ranked among the 100 best performers. Not only do those 100 receive bragging rights, but their stock picks are used as the basis for a real mutual fund, managed by Ken Kam. These top players, called the m100, currently have their largest portfolio concentration in gold shares. Here's a special report on gold issued by the m100.
"A majority of the gold miners have experienced share price appreciation in 2002, as gold has advanced significantly for the first time since 1993. At the start of 2002, the m100 held 2.1% of their portfolio in the Materials sector (which includes gold) yet that weighting has grown, both through price appreciation and stock purchases, to 29.4% at year-end. Though not all m100 members share the strategy of participating in the Gold sector (currently about 13% of m100 members are primarily invested in Gold stocks) the investment has served the group well as a part of a well-diversified portfolio. For the year, the m100 returned -2.80% compared to a -21.97% loss for the S&P 500.
"The advance in the price of gold this year comes amidst a bear market for the metal lasting over two decades. At its height in 1980, the spot price for gold stood at $850/oz. But from 1980 through to the beginning of 2002 that price tumbled more than -67.5% to $276/oz., as confidence in stocks, bonds, and currencies led investors away from gold. The low gold prices discouraged production by major gold miners and thus tightened the overall supply of the metal. As the price for gold has advanced in 2002, investors have noted that production may once again increase as a growing demand for gold exceeds supply. However, before investing accordingly, it is important to establish the underlying macroeconomic factors which will aid or thwart gold's future price movements. A look at each of those factors gives us a roadmap to invest prudently in the industry heading into 2003, while also warning us of potential risks tied to gold investments.
"Markets don't like uncertainty, and much of the broader market's choppiness in the recent weeks can be partly associated with the threat of a war with Iraq. There is no doubt that some money has flowed into the gold industry as a result of the geopolitical climate as investors seek downside protection. However, in our opinion the war with Iraq alone is not reason enough to move money into the gold miners.
"Historically, gold prices have been negatively correlated to the US Dollar (USD), as the world tends to choose what 'currency' to hold given its predicted returns. The relative strength of the USD for much of the last half-century has made it possible for these other nations to hold USD in reserve, anticipating that they would realize a higher relative return than if they had held other currencies, or gold. However, the US economic recession has prompted the Federal Reserve to slash interest rates, effectively pumping up the money supply (known as M1 to economists). A larger supply of USD along with a faltering economy has weakened the USD relative world price, and forced other nations to consider alternatives to holding USD. Because the recession has been global in nature, these nations have been stepping into gold positions in expectations that gold as a static asset will retain its value even as world currencies lose theirs. Though the scenario above has yet to completely unfold, we believe that the US Federal Reserve's stance on monetary policy leaves room for the dollar to weaken, which in turn would put upward pressure on gold prices:
"The news that bullion dealer Blanchard & Co has accused J.P. Morgan and Barrick Gold of gold-price manipulation is also bullish for the future of gold. Blanchard claims that Morgan and Barrick joined to make $2 billion in short selling profits by suppressing the price of gold. The claim suggests that gold prices should be higher today had they been allowed to find an equilibrium free of price manipulation. If nothing else, the removal of one such practice gives investors more confidence to invest in the industry.
"Since there are only about 20-30 public companies available for investing, the sector has a whole tends to benefit from any rising tide in gold prices. Here is a review of some of the m100's favorite gold stocks, based on both their current holdings and trading activity:
"Harmony Gold (HMY NYSE) is our pick for a core investment within investors' gold allocation. Based on the company's reasonable fundamentals and technical indicators, HMY could do spectacularly well in the event of a continued rise in gold or a geopolitical flare-up. And even if the market recovers and a war with Iraq doesn't take place, HMY still has reasonable earnings, dividends, and prospects for a profitable future. Harmony is somewhat less leveraged to the price of gold than some of its peers which makes it a relatively more stable pick in the industry. Harmony Gold is a South African miner, which means that investors should be mindful of the rand (South African currency) to USD relationship. Gold is priced and sold in USD, so if the rand rises against the USD, as it had in the early part of last year, the price a South African miner like Harmony receives in rand is lower than it would otherwise be. In the event that that happened, Harmony's costs expressed in USD would rise.
"Another South African miner, Gold Fields (GFI NYSE) is another company with strong fundamentals to back its exposure to the upside in the price of gold. Company management actually reinforced our positive view of GFI recently when they withdrew a new share offering citing the fact that market conditions were such that they would receive too little money for what they believe to be already undervalued shares. As a South African miner, Gold Fields faces the same potential downside as Harmony Gold does.
"Relatively speaking, North American miner Goldcorp (GG NYSE) is a somewhat more risky investment within the industry based on its elevating valuation. However, Goldcorp is an attractive holding based on bigger profit and operating margins tied to Goldcorp's heavier leverage on gold prices. Specifically, GG has moved some of its cash into bullion, giving the company a higher risk and reward payout based on the movements in gold prices. Goldcorp's valuation is high relative to the industry. As gold issues move up, Goldcorp may lag behind its peers in share price gains. Its increased leverage to the price of gold gives the company an opportunity to offset this effect as gold rises, but also lag heavily in the event of a gold price decline.
"Working in favor of Glamis Gold (GLG NYSE) is its strong reaction to the run-up in gold stocks this year. The unhedged miner outperformed the aforementioned HMY, GFI, and GG in 2002, largely due to the greater sense of stability investors have found in the company's US and Central American based operations.
"Durban Roodeport (DROOY NASDAQ) is another South African miner that has performed well against its peers. This company is considered a junior miner because of its size relative to competitors. Yet the juniors continue to be a spot of major investment for the m100, as they provide likely targets for consolidation."
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