Potential for further highs for gold

Steve Land, CFA, is portfolio manager of Franklin Gold & Precious Metals Fund, Franklin Templeton Investments

The recent period of global economic uncertainty has had a mixed impact on the precious-metals sector. Many commodities struggled during the second quarter as disappointing US economic data, sovereign-debt problems in Europe and euro volatility created doubts as to the true strength of the global economic recovery. In addition, questions about the durability of China’s economic growth further dampened the outlook for commodities demand.

There was some upbeat news in June, though, with US industrial production and durable goods orders rising strongly, reducing some economic worries, while the outlook for increased materials demand from China jumped.

Performance among the four primary precious metals was divided in June, as gold and silver appreciated while platinum and palladium continued to struggle following their large declines in May. Gold capped its biggest quarterly gain in more than two years as signs of unwieldy sovereign debt levels in the western world and an increasingly fragile economic recovery stoked demand for the metal as a safe haven. Gold also rose after the Federal Reserve said it would keep US borrowing costs low for an extended period, which may weaken the US dollar.

Silver has been steadily outperforming, recording its sixth straight quarterly gain and longest rally since 1979. Notably, investors accumulated record amounts of gold and silver in exchange-traded funds backed by both metals.

As investors continued to flee to the perceived safety of gold and silver in June, other precious metals that are more closely linked to economic activity, which many analysts viewed as ebbing, declined in value. In particular, platinum and palladium have come under pressure due to their tie to the auto industry and reports of declines in European auto registration as well as a sequential slip in US car sales in June.

Although they are more economically sensitive than gold, platinum and palladium are also hard assets that can appeal to investors who want to diversify their portfolios. Platinum has been seeing significant investor interest, while palladium has been exhibiting strong momentum over the past year, bolstered by improving auto sales and investor demand.
We still believe there is meaningful investment opportunity in precious metals, as they can be a good diversification tool in an overall portfolio strategy as well as a hedge against inflation, which appears to be a real possibility in light of loose monetary policies around the world. As we look at the landscape over the next couple of years, we continue to see a lot of uncertainty, so it makes sense to own some gold over the long term.

In addition, we believe there is still potential for further highs for gold. For example, China has stated in press reports that it plans to continue building its reserves, which remain low compared with the rest of the Western world. India also has stepped into the market, buying 200 tonnes of International Monetary Fund gold back in November 2009. We also continue to see Russia acting as a large buyer. These are three major economies that continue to add gold to their central banks, supporting our view that gold prices could continue to rise.

There is no question that gold is still vulnerable to market downturns, but the appeal of gold is its historically low correlation with the overall markets. It should be noted that at Franklin Templeton, our investments are in gold equities through companies that tend to mine gold, not in gold boullion. The same is true for other precious metals that we invest in through our funds. We focus our investments in high-quality mining companies with strong balance sheets, low-cost structures and significant growth prospects. The current environment of high precious-metals prices provides what we regard as an excellent backdrop for companies to potentially create shareholder value through improving profits, reserve additions, new mine developments and exploration success.


Written by Steve Land  
The Edge Malaysia