There’s a strong contrarian argument for investing in gold, particularly in the gold mining sector, according to Chelsea’s Darius McDermott (pictured). 
The managing director, who has held gold funds in his personal portfolio for a number of years, is standing ground on his investment decisions ahead of an expected impending rise in inflation.
“I have to say, [gold is] one thing I’ve been a bit wrong about over the last four or five years. Not only has the gold price not really done much since at peaked at nearly $2,000 in 2011, it’s now $1,200,” McDermott said.
“Also, the disconnection between gold prices and gold mining companies has continued to grow in recent times. But, it is a well-held assumption that if inflation returns to the system then gold will do well.”
“Without a big inflationary push, gold will probably continue to stay in the $1,200 to $1,300 range.”
While McDermott thinks we will get some inflation, he can see how other financial experts are becoming increasingly concerned.
He said: “I spent some time with [Investec’s] Alastair Mundy the week before last and he’s very worried about inflation.”
“A point he made that I thought was quite good is, when everybody’s expecting deflation, you often get inflation. When quantitative easing started, everybody expected it would lead to inflation but it hasn’t. It certainly hasn’t yet.”
Despite quantitative easing (QE) failing to increase inflation so far, it did prove to be supportive of gold at some points in the past.
A recent report from Crossborder Capital states that the increasing number of central banks printing money will help to push up gold prices, as it did when the Federal Reserve first started its own quantitative easing programme.
The report said: “The antithesis of paper money is gold. Therefore, generally strong private sector liquidity relative to central bank liquidity should precede a weak gold price.”
“Similarly, strong central bank liquidity and weak private sector liquidity is likely to align with a
strong gold price: we can call these qualitative forces ‘bad’ and ‘good’ money, respectively.”
“In short, the prospect over coming months of more and more central banks jumping on to the QE bandwagon in attempts to lift domestic economic activity will boost the supply of ‘bad’ money and probably mean a jump in the value of gold well above its prevailing $1,200 per cent trend.”
The graph below shows how this trend has played out in the past, comparing world private sector liquidity, central bank liquidity and the nominal gold price from 1981 to 2015.
Source: Crossborder Capital
This trend has not been ignored by investors as an increasing number of financial experts are beginning to buy back into gold.
Scott Baikie, senior portfolio manager at Thomas Miller Investment, is surprised that QE has inflated almost all assets within recent years apart from gold, although he acknowledges that some consolidation was justified after the 10-year bull run the yellow metal enjoyed up to 2011.
“Our recent interest in gold stems from its merits as a hedge against negative returns from other asset classes,” he explained.
“With this in mind, for us, a physically-backed ETF provides the most effective route to market for our clients. Whenever the next crisis arrives, we wonder what extremes central banks will go to in order to stimulate demand – such behaviour cannot be good for fiat money.”
ETFs are a popular investment vehicle for gold due to their fluidity in trading and the practicality of not having to store physical bullions or coins.
However, McDermott believes that, during this stage of the cycle, gold mining funds are potentially far more attractive.
“I think gold miners are one of the most unloved parts of the stock market during the bull market, so I think there’s a sensible contrarian argument there,” he said.
“When gold goes up, historically gold miners outperform the gold price, so it’s like getting a slightly leveraged play – although they have been a shocking place to invest during this bull market.”
In his personal portfolio, McDermott currently holds the five FE Crown-rated Smith & Williamson Global Gold & Resources fund, which has a mid and small-cap bias and is run by Ani Markova.
“[Markova] is actually based in Canada – she feels being local to that market puts her at an advantage,” he added.
Since the start of the year, the fund has in fact underperformed its peer average in the gold mining sector by 1.26 percentage points.
Fund vs average IA gold fund over 2015
Source: FE Analytics
McDermott says that this is because most funds with a small-cap focus will underperform when the stocks are unloved, but will outperform when the sector is being supported by the market.
“Gold mining shares have just done badly full-stop in the last four or five years and small-caps in gold mining have been no exception to that, so it hasn’t been a good place to be,” he admitted.
However, Markova’s fund has managed to outperform its peer average since her tenure, making losses of 50.08 per cent, which is 8.55 per cent.
Fund vs average IA gold fund since management tenure
Source: FE Analytics
While this is still an eye-watering loss, it must be noted that gold has had a particularly disappointing last few years as mentioned above. However, the strong sell-off may have given rise to a contrarian value opportunity.
The fund, which has an 82.4 per cent weighting in the US, has companies such as Agnicao Eagle Mines, Goldcorp Inc and Newmont Mining Corporation in its top 10 holdings and has a clean ongoing charges figure (OCF) of 0.72 per cent.
“I think having some gold now is probably a good idea as a means of diversification and also because of the expectation of some inflation,” McDermott continued.
“I just don’t expect inflation to go roaring this calendar year – it may well do in later years but I don’t expect it’s going to go massively up in the short term.”
“But, I think you’ll get a better return if gold and gold miners do well out of that sector.”