With investors seeking safety from battered stock markets, and growing anxiety about a possible war between Iraq and the United States, gold bullion has gained about 14 per cent since the start of the year.
The combination of a rising gold price and market jitters has pushed up the value of gold stocks, making precious metals funds one of the few shining areas.
And within the category, the $218.5-million Royal Precious Metals Fund has been a standout. It returned 80.8 per cent for the year ended Oct. 31, versus 46.2 per cent for the group average. That made it the top performer in the category and among all funds available in Canada.
"I attribute the performance to the fact I am very much committed to a higher gold price," says manager John Embry, vice-president of Canadian equities at Toronto-based RBC Global Investment Management Inc.
"I'm seeking companies that will benefit the most from that type of environment," adds the 39-year investment industry veteran who has managed this fund since April, 1994.
As a result, he's avoided major blue-chip producers such as Barrick Gold Corp. and Placer Dome Inc. These firms have extensive hedging programs that ostensibly protect them from a falling gold price but also prevent them from benefiting from a rising price.
"In the event of a higher gold price, they will either have problems with their hedge book or won't perform as well as unhedged companies," he says. It was a good bet: these players have barely moved in the last 12 months.
But Mr. Embry's investment in mid-cap, unhedged producers such as Meridian Gold Corp. have paid off big time. Bought at an average $7 a share in late 2000, it is now trading around $27.
The second aspect of his investment stance was a decision to buy a number of little followed small-cap producers. These account for about one-third of the 60-name fund, on a weighted basis.
For example, he bought Eldorado Gold Corp. for about 50 cents a share a year ago. The junior firm, which has interests in Brazil and Turkey, has risen to about $1.70.
Thistle Mining Inc., which has acquired the President Steyn mine in South Africa, cost about 20 cents when he bought it last year. It trades at about 65 cents.
"These kinds of stocks, when added to my core holdings, make a big difference. They add ballast to the fund," Mr. Embry says.
Core positions, which make up about three-quarters of the fund, include such firms as Repadre Capital Inc. and Iamgold Corp., as well as River Gold Mines Ltd. and FNX Mining Co. Inc.
Going forward, Mr. Embry remains very upbeat on the sector, but has reduced holdings such as Meridian Gold, which he believes have become too expensive.
Instead, he has focused on low-margin producers that will stand to benefit more from a higher gold price. This accounts for his acquisition of names such as Kinross Gold Corp. and TVX Gold Inc.
Mr. Embry argues that gold stocks, having risen from their lows in late 2000, finished the first leg of a bull market last May. They went through a corrective phase over the summer and fall, and are poised to start the second leg. But, he admits, it all depends on a much higher gold price.
How much higher? He sees gold rising to $400 (U.S.) an ounce by mid-2003 from about $319 now, and then hitting $500 "should conditions deteriorate sufficiently."
A long-time gold bug, Mr. Embry encountered some unwanted publicity last June when the media picked up a report he wrote for internal consumption. In it, he pointed to growing evidence of gold price manipulation since 1995. He argued that central banks and so-called "bullion banks" that have been short-sellers have a common, vested interest in keeping the gold price low.
The report proved fodder for conspiracy theorists. Today, Mr. Embry is reluctant to discuss the report, hinting that it caused some embarrassment to the Royal Bank. But his conviction remains unwavering. "The fundamentals behind gold are getting better and better," he says.
His argument is posited on a weakening U.S. dollar and the U.S. current-account deficit, which is 5 per cent of gross domestic product. "When a country runs that kind of deficit, the currency usually buckles."
Mr. Embry notes a correlation between gold and the greenback. "If the dollar is seen as a less attractive currency, not all the money will move into the euro or yen. At the margin, some of it will move into hard assets, such as gold."
The second leg of the bull market will be apparent as investors move into gold stocks in a bigger way. "This leg could last a couple of years," he says.
Acknowledging the sector is notoriously volatile, he adds that the third leg could end up in a speculative blow-off, much like tech stocks. "But it all hinges on a higher gold price," he says, arguing that a combination of a weakening U.S. fiscal condition, record-low interest rates and dismal equity returns will prompt people to buy bullion directly.
"The competition for gold is materially less than it has been for the last 20 years," he says. "As these problems manifest themselves, people will view gold more favourably."
While Mr. Embry paints an attractive picture, analysts recommend caution.
"These funds have a history of big ups and big downs," says Gordon Pape, Toronto-based co-author of the 2003 Mutual Fund Buyer's Guide, who considers the fund "one of the best precious metals funds around."
Yet he reminds investors that the fund also had four consecutive negative years, from 1997 to 2000.
Mr. Pape warns that gold stocks are vulnerable to factors such as rising interest rates, making for hazardous going. But he maintains that "if you're going to walk into that particular mine field, this is one of the better ways to do it."
James Gauthier, fund analyst at Toronto-based Dundee Securities Corp., does not recommend holding more than 5 per cent in any precious metals fund.
Though impressed with Royal Precious Metals, it is not his first choice. He prefers the $123.8-million Mackenzie Universal Precious Metals, which came second in the category on a one-year basis and first over three years. "Its performance is a bit more consistent," he says.
© 2007 The Globe and Mail. All rights reserved.
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