A bright outlook for gold miners

Our cover special report this week looks at some of the problems afflicting the commodities sector, but Mr Smith is not overly concerned. "I don't think demand is the problem going forward, but rather supply: we don't ever see the forecast supply getting to market. Companies are delaying capital expenditure due to rising costs, and the market and banks are not allowing major projects (to improve infrastructure and supply) to go forward. In the past five years the story has been about demand, the next five years will be about supply."

The last time we spoke to Mr Smith, in 2011, around 35 per cent of the trust's portfolio was allocated to gold mining shares, and he said that this would not reduce until there was:

■ a return to real interest rates and traditional growth in OECD countries; and

■ a credible solution to sovereign debt issues.

Read our previous interview with Mr Smith

Scroll onto 2012 and, with around 30 per cent of the portfolio invested in gold securities, not much has changed. "The fundamental reasons for this level of allocation are still there and I like gold miners' shares on a valuation basis," he says. "Plus, margins are good and gold miners have increased their dividends significantly."

For example, Australia-listed Kingsrose Mining has significant exploration prospects and needs to commit resources to this. But, because it is producing gold at a reasonable cost this year, it has been able to declare a maiden dividend of 4¢ per ordinary share.

"We remain committed to gold as an asset class," says Mr Smith. "It is good insurance because of the financial problems, to which monetisation (a cause of inflation) is an easy solution for monetary authorities. But I am not saying that gold is necessarily the best hedge against monetisation, copper may be better because of its supply/demand issues.

"The nightmare scenario would be if the gold price went through the roof, but the market crashed taking down gold mining shares. However, because their balance sheets are so much stronger than in 2008 (when markets crashed), this provides a degree of protection as they are cash-rich and pay dividends. The amount of gearing (debt) they have is also far less than in 2008."

Also read Simon Thompson's view on gold

Overall, Mr Smith thinks there are several good reasons as to why investors should have an allocation to commodities. "Now is a good time to invest because valuations are at historic low levels, especially gold mining shares, which used to be at a premium to other miners but are now at the same levels. Many companies are returning to the dividend list, which is good news in view of low interest rates," he says.

Also, merger and acquisition (M&A) activity has persisted in the gold sector as more stragglers have been picked off by predators. Witness Silver Lake Resources' bid for Integra Mining and Endeavour Mining's bid for Avion Gold. In addition, Barrick Gold announced that it was in talks to sell its 73 per cent stake in African Barrick, a notable underperformer, to the Chinese. "Strategic players are happy to acquire smaller companies at these valuations, as it is cheaper than building new facilities to extract resources," says Mr Smith. "Markets like this give them the opportunity to buy. This has led to a steady flow of M&As, which should continue."

Soft hope

An area on which Mr Smith is less bullish is soft commodities. "We have looked really hard at this area and found that there are very few sensible ways to play it," he says. "Fertiliser, potash and phosphate are in demand, but the companies that make it are few."

He doesn't expect the US drought to help these companies even if it has pushed up the prices of some soft commodities. "It doesn't mean farmers have more cash and if crops fail they won't want fertilisers. The share prices for these companies haven't moved much."

A company he does like is New Britain Palm Oil, the trust's second-largest holding, despite a recent setback. "New Britain Palm Oil released half-year results which disappointed the market due to currency losses and production shortfalls caused by abnormal rain," he says. "The stock initially fell 30 per cent, but subsequent meetings with management reaffirmed our view that this is a temporary setback for a premium company. If all companies were as well run as New Britain it would make our life easier."

So where are the opportunities? "Where are there not opportunities?" enthuses Mr Smith. "We keep coming across fascinating ones. We look at outlying areas because the easy opportunities have been found and there is a need to drill deeper. You need to be aware of technology and the possibilities this raises, for example, horizontal drilling."

Within the oil and gas sector, for example, recent drilling results in the Liard Basin in Canada have validated one of the most prolific shale gas plays in North America for US-listed Apache. Oil and gas is a sector to which the trust has increased its allocation in recent years "because of fascinating opportunities", so that it now stands at around 22 per cent.

"But there is no one area of specific focus in terms of opportunities," he adds. "The long-term story for emerging markets' commodity demand is intact. China and India have huge populations and the cumulative total demand will be massive over the long term at the same time that supply is failing to meet demand."