The price of gold has a reputation for going through spurts. Over the past five years it has jumped, then pulled back, and then jumped again, on repeat. This year has seen a strong rally for the precious metal price, leading investors to ask if there is more to come.

At $2,424 per ounce, gold returned 17.4% year-to-date which is more than three times as much as the FTSE 100’s 5.5% performance. It is also streets ahead of gold’s 9.5% annualised return over the past 20 years, as calculated by SharePad.

A double-digit return from gold in 2024 is certainly welcome for investors holding the shiny stuff in their portfolio, but what is interesting is how it has done so well in a year when there has not been the typical ‘unwelcome news’ environment that traditionally benefits the metal price.

Think why people like to invest in gold – it is often because the metal is considered to be one of the few assets to hold or grow its value during times of strife. For example, Russia’s invasion of Ukraine triggered a big rally in the price of gold. It can also be a hedge against extreme events and inflation, the latter partially explaining why it has done well in recent years when the cost of living soared.

THE CHINA EFFECT

Chinese investors have been among the buyers of gold in 2024 as they turn their back on the troubled real estate market and redeploy savings into the precious metal. China’s central bank has also been a major buyer of gold since last year. That has echoes of 2010, which the World Gold Council declared to be ‘an outstanding year’ for the metal when central banks became net buyers of gold for the first time in 21 years.

After feasting on gold for an extended period, it is important to note that China’s central bank refrained from adding gold to its reserves in recent months. That has led investors to wonder if we are now moving to the next phase in the gold market whereby further price hikes require greater global investment demand.

In June, investment bank BofA predicted gold could hit $3,000 per ounce over the next 12 to 18 months. That implies a 24% return from the price of gold at the time of writing. BofA says achieving this target is dependent on a pick-up in non-commercial demand, which in turn needs the Federal Reserve to start cutting US interest rates. Markets currently believe we will see the first rate cut in September.

HOW TO INVEST IN GOLD

Investors can obtain exposure to the gold price through various means. If they do not fancy owning physical gold in the form of coins or bullion, alternatives include tracker funds which mirror the performance of the gold price or actively managed funds which invest in a portfolio of gold miners or gold exploration companies.

Taking the mining route depends on an investor’s appetite for risk as things can go wrong with this industry. In addition to commodity prices being out of miners’ control, gold producers and explorers must also contend with risks associated with operating in remote parts of the world, emerging market governments constantly fiddling with the tax regime around natural resources, and geological challenges such as variable grades of ore.

TURNING POINT FOR MINERS

Certain investors take the view that an investment in gold miner should outperform a rising gold price – while also underperforming when gold is declining in value.

Rob Crayfourd, one of the managers of investment trust Golden Prospect Precious Metals (GPM), explained this concept on a recent episode of the AJ Bell Money & Markets podcast. He said: ‘The miners should have operating leverage. If you say gold is at $2,000 per ounce and costs are $1,000 per ounce, a 10% increase in gold should be a 20% effective increase in margins for the miners and therefore they should outperform gold in a stronger market.’

Interestingly, this concept has not played out as expected in recent years. Miners have lagged the rising gold price because cost inflation has compressed profit margins.

For example, Barrick Gold (GOLD:NYSE) is one of the world’s biggest gold producers and its shares have this year traded on their cheapest price to earnings valuation metric since 2015. The stock currently trades on 13 times forward earnings, lower than the 40 times earnings level which it eclipsed in 2016.

The gold mining industry has had to stomach a significant increase in the cost of things like energy, steel, acid and labour. These inflationary pressures are now starting to ease. We might be at an important turning point for the gold mining sector which could put the industry back on the radar of investors.

The price of gold jumped by 22% from $1,989 per ounce to $2,412 per ounce between mid-February and mid-April this year and has held firm above $2,300 per ounce ever since. This spike should benefit the next few rounds of quarterly results by gold miners and potentially lead to a re-rating in sector share prices, particularly as the period might also show lower cost inflation and therefore stronger profit margins. There is no guarantee that will happen, but it is something to consider.

‘We should see higher revenues translating into better margins and better free cash flow generation,’ says Crayfourd. ‘Ultimately, that is what drives the miners. They are driven by earnings, not just the headline gold price.’

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