Last week's debt crunch and the resulting stock market rout have fanned fears of a systemic breakdown in global financial markets.
While we're not there yet, it's precisely this kind of scenario that inspires Simon Fenwick, co-manager of the $1.1 billion
First Eagle Gold Fund(SGGDX), to stick to a narrow investment mandate of gold bullion and gold stocks.
For a long time that strategy was a winner: Prices of both the metal and mining stocks more than doubled in the four years to January 2007, allowing the fund to log annualized returns of nearly 20% over the period. But it has really penalized him this year, as the price of gold rose 1% in the first half, while gold stocks, as represented by the Amex Gold Bugs Index, were essentially flat. Fenwick actually lost money, giving up 2.7% through June 30.
Meanwhile, some his peers who hold a more diverse group of metals stocks, including producers of platinum, lead, zinc, iron ore and copper, shot to the sky in the first half on robust demand for industrial materials.
Fenwick has no regrets, however. He says gold has a unique quality that compensates for its recent weakness. "The reason we own gold, and believe investors should own gold, is as an insurance policy against a major financial accident," the manager says. "Although base metals miners do well during an inflationary period, they tend to fare poorly in deflation" when prices are falling.
Straying from his investment strategy would be a major disservice to investors who should own the yellow metal, he says, not for the "price quoted on a
" terminal, but rather what it can buy when the values of other assets are falling. He notes the metal has tended to hold up well in widely diverse scenarios.
Such tectonic crises would certainly include the huge consumer price inflation of the 1970s, when gold shot up from $35 an ounce to a peak of over $800, and the Great Depression of the early 1930s, when consumer prices fell like a stone while gold held steady at $22 an ounce.
Fenwick's fidelity to gold isn't the only thing that sets him apart. He also has an unusually large holding of bullion, which represented slightly over 25% of the total value at the end of the second quarter. That's a contrast with the more traditional approach employed by money managers who favor the stocks of miners over the metal because of the leverage they provide.
That's because a miner making $100-an-ounce profit with gold selling for $500 an ounce will see margins double if gold lifts only 20% to $600.
Fenwick says that while gold stocks normally lead the metal higher, there have been periods, such as the late 1970s, when the opposite has occurred. He believes we are in another such period now, because there's less high-grade ore available. That means miners must grind more rock to get the same amount of gold. So costs have risen faster than the price of gold, keeping a lid on share prices.
When Fenwick does invest in gold-mining companies, he sticks to small-cap stocks, particularly those that operate in low-risk countries, have proven themselves to be economic and are undervalued.
Right now, there aren't many candidates.
small-cap mining stocks seem priced to perfection right now on the perception that they will all be acquired by larger gold companies," says Fenwick. "Some will be acquired, but many will not."
Right now the fund has an uncharacteristically large allocation to large-cap stocks, with stalwarts
taking the first two slots after bullion, each making up 9% of the overall value. Other top holdings include
, all firms with substantial market caps.
Fenwick isn't the only gold fund manager spinning his wheels. Other specialty precious-metals funds with lackluster performance include the
U.S. Global Investors Gold Shares fund (USERX), which lost almost 7% in the first half.
Frank Holmes, portfolio manager of U.S. Global Investors Gold Shares, says a narrow investment mandate isn't the only thing holding his fund back. Some of the mid-cap firms he has owned, such as
, have failed to deliver on their production forecasts and have then seen their stocks punished as a result.
Some of the best-performing funds in the sector have taken the opposite tack. For instance
Vanguard Precious Metals and Mining (VGPMX) grew 23% in the first half, fueled by gains from what can only be described as a non-gold portfolio.
At the end of June, not one of fund's the top 10 holdings was a gold firm, according the data on Vanguard's Web site. And information for the first quarter shows that the vast majority of the portfolio was similarly skewed. Instead, the fund's top 10 include platinum producers Lonmin, Johnson Matthey and Impala Platinum. Platinum is technically a precious metal, but its price is determined almost exclusively by industrial demand, and in that sense it is more like a super-expensive base metal.
Vanguard Precious Metal's other top holding sinclude diversified miner
, as well as
, a European fertilizer maker, and
, a metals recycler.
Midas Fund (MIDSX) which increased about 12% over the first 26 weeks of 2007, held more than a few non-gold stocks. It had some of the same top holdings as Vanguard Precious Metals, including Rio Tinto and Lonmin, as well as
Freeport McMoRan Copper and Gold
, which despite its name is primarily a base-metals miner, and diversified mega-miner