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Focus on Gold?

When betting on mining stocks, take a more diversified approach than casting your lot purely with gold miners…

Granted, the World Gold Fund has been around for a longer time than the World Mining Fund, but that is not the only reason why its corpus is bigger. Gold, as an investment, tends to have a larger fan following than any other metal, and all the more in India. So naturally, the World Gold Fund does have a stronger appeal amongst investors than the World Mining Fund. When you invest in either DSP BlackRock World Gold Fund or DSP BlackRock World Mining Fund, there are quite a few similarities. Investors must understand upfront that in neither case will the fund hold physical gold, silver or any metal - precious or otherwise. The investment will take place in stocks of companies in the business of extracting, processing and marketing of gold or whatever be the metal in question. So the investment is in companies engaged in the business of mining metals, precious metals or precious stones. Geographically, the investment universe is not limited - investments will take place in companies across the globe.

Another similarity is that both funds won’t actively buy the stocks themselves but will invest in other international funds sharing an identical mandate. DSP BlackRock World Gold Fund will buy into the units of BlackRock Global Funds - World Gold Fund, while DSP BlackRock World Mining Fund will buy the units of BlackRock Global Funds - World Mining Fund.

In that sense, the funds are similar. The difference arises in their investment universe.

The World Mining Fund invests globally at least 70 per cent of its total assets in the equity securities of mining and metal companies whose predominant economic activity is the production of base metals and industrial minerals such as iron ore and coal. The World Mining Fund may also hold the equity securities of companies whose predominant economic activity is in gold or other precious metal or mineral mining.

On the other hand, the World Gold Fund invests globally at least 70 per cent of its total assets in the equity securities of companies whose predominant economic activity is gold mining. It may also invest in the equity securities of companies whose predominant economic activity is other precious metal or mineral and base metals or mineral mining.

So while there could be a duplication of some stocks and sectors, it is the percentage allocation that makes all the difference. According to the June portfolios, there is just one stock that features in the top 10 of both portfolios - Newcrest Mining, however, the actual allocation to the stock is starkly different (see Top Stock Holdings). Similarly, while there is an overlap of five industries (see Sector Allocation), the percentage allocation differs.

Both funds have more than half of their portfolio in 10 stocks (see Top Stock Holdings). It may appear concentrated but if one takes a look at the actual allocation to each stock, there are no major risky bets here. The concentration is more apparent in the regional exposure; the World Gold Fund takes a huge exposure to North America while the World Mining Fund is more evenly distributed between Europe and North America.

There is no denying that these funds are good options if you want an exposure to mining stocks, including gold mining stocks. The brand is extremely well known. As of March 31, 2011, BlackRock’s assets under management totalled US$3.65 trillion across equity, fixed income, cash management, alternative investment, real estate and advisory strategies, making it the world’s largest asset manager.

Having said that, despite the global exposure and the well diversified portfolios, end of the day these are thematic funds. At Value Research, we have always been consistent in our view on this aspect - limit the exposure to such products to not more than 15 per cent of your overall equity exposure. Further, we would advice investors who want an exposure to international mining stocks to consider the World Mining Fund and not restrict their exposure to solely the World Gold Fund. If it is an exposure to the yellow metal that they are keen on, then it would be better to invest in a Gold Exchange Traded Fund (Gold ETF). But if it is stocks that one is going after, then it’s better to take a more diversified view. Should the world get bearish on gold, or, alternatively, should the world get very bullish on metals other than gold, then the World Mining Fund has a better chance at providing better returns. For instance, in the last two quarters of 2010, the World Mining Fund delivered 17.57 per cent and 20.80 per cent. The corresponding figures for the World Gold Fund were 9.41 per cent and 10.26 per cent.

In February 2011, the fund manager’s commentary on the World Mining Fund portfolio revealed that the fund’s position in First Quantum was one of the top outperformers as the market gave credence to the strength of the company’s copper growth over the next few years. The fund also increased the exposure to two companies operating iron ore developments in Sierra Leone. They both offer, in their view, compelling medium term valuation and positive near term catalysts. As a key input for steel manufacturing, iron ore is one of the most important industrial commodities in the world and has been one of the most significant drivers of mining sector profitability over the last decade. What better way to participate in this growth than buying units of such a fund? This opportunity would be lost if you invested only in the World Gold Fund.

We cannot emphasize enough that before investing in such a fund, investors must be clear that investing in mining stocks is not the same as investing in the underlying metal. The performance of mining shares has a high correlation to the movement of the price of the underlying metal. While it falls harder, it also rises higher because the earnings of the miners usually rise more than the price of the relevant metal. However, this tends to work in “normal” times. This correlation did not work in 2008 due to the situation in the global financial markets. Mining stocks could not escape the selling panic in the general equity and commodity space.

So before taking the plunge, be prepared for a rocky ride which is dependent on the underlying metal prices as well as equity market movements.