Investors who have missed out on the rally in gold prices can consider a riskier proxy – stocks of gold mining companies. The DSP BlackRock World Gold Fund invests in a portfolio of gold and precious metal producers from around the world.

Since its inception in 2007, the DSP BlackRock World Gold Fund has delivered a 19.8 per cent annualised return. With 17 per cent gain in its net asset value (NAV), this fund has lagged physical gold prices in the last one year.

A catch-up appears likely, as gold miners benefit from better margins and adopt more shareholder friendly practices.

Why catch-up

After moving almost in step with gold prices until late 2010, stocks of gold mining companies have failed to keep up in 2011.

Here are the reasons for the underperformance and the mitigating factors: One, while economic uncertainties have helped physical gold prices, they have put stock markets and therefore gold mining stocks under selling pressure.

However, with realisations from gold outpacing costs for miners, margins have improved substantially. The top three mining companies in the DSP World Gold Fund's portfolio for instance had operating profit margins of 50-60 per cent in the last year.

Two, criticised for their poor governance practices and low distributions to shareholders, gold mining companies are now raising their dividend payouts. This trend could provide a trigger to stock valuations.

Three, the very nature of mining activity exposes gold mining companies to regulatory activism.

However, the World Gold Fund has tried to resolve this through geographic diversification. In its latest August 2011 portfolio, 39 per cent of the fund's exposure was to Canadian companies, with South Africa 14 per cent, and Mexico 13 per cent following well behind.

Not a safe haven

Though DSP Blackrock World Gold Fund has the potential to deliver high returns even over the next one year, investors in the fund should take note of two risks.

One, gold mining stocks are no safe havens as they are impacted by swings in both gold prices as well as stock markets.

Two, gold being a commodity, has no ‘intrinsic' value to determine whether it is an overvalued or undervalued asset.

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