November 26, 2022

Gold Stocks Are Positioned For An Explosive Move Up

Historically, gold stocks have outperformed gold bullion.  Mining companies typically benefit from leveraged earning gains as gold prices rise and production costs remain stable.  Higher gross profits on each ounce of gold produced flow right to the bottom line, boasting profits and stock prices.

During the initial phase of the gold bull market, investors reaped greater profits by owning a basket of gold mining stocks as opposed to holding gold bullion.

Using the PHLX Gold/Silver Index (XAU) as a proxy for mining stocks, the XAU significantly out performed gold bullion during the initial stages of the gold bull market from 2000 through 2008.  From 43.87 in October 2000, the XAU advanced to 195.25 in June 2008 for a gain of 345%.  During that same period of time, gold rose from $264 in October 2000 to $930 in June of 2008 for a gain of 252%.

XAU GOLD/SLVER INDEX - COURTESY YAHOO FINANCE

Since 2008, however, the price correlation of gold mining stocks to gold bullion has reversed.  Despite a doubling in the price of gold since 2008, the XAU is only marginally higher at 210.93 for a very paltry gain of 8%.  An investor who was super bullish on gold since 2008 would have gained virtually nothing in mining stocks while the price of gold soared.

Investors in broadly diversified precious metal mutual funds had equally poor results.  As of June 2011, both the Vanguard and Fidelity gold mutual funds have drastically under performing gold bullion since 2008.  The Vanguard Precious Metals Fund (VGPMX) actually delivered a horrendous three year return of minus 0.46% as the price of gold soared 80%.  The only investors in gold mining stocks since 2008 who made profits were those astute enough to pick the handful of mining stocks that out performed gold bullion.

Even the Tocqueville Gold Fund (TGLDX), run by legendary gold investor John Hathaway, has been unable to outperform gold bullion since 2008.

 

XAU, GLD, TGLDX - COURTESY YAHOO FINANCE

Some of the reasons for the disconnect between gold mining companies and gold bullion since 2008 include the following.

  • Investors learned the downside risks of leverage during 2008 when gold stocks got absolutely crushed while the price of gold bullion had a relatively modest decline.  As measured by the XAU, gold stocks declined by a devastating 65.7% during 2008 while gold bullion declined by only 29% from a peak of $1,011 to a low of $713.
  • A growing preference for holding physical gold and silver.
  • The realization by investors that it takes an in-depth technical knowledge of the mining industry as well as the ability to analyze financial statements to be able to pick the gold mining stock that will outperform gold bullion.
  • Gold mining companies can go bankrupt while gold bullion is eternal and will always retain a value and constitute a store of wealth.  Long time gold investors may remember stocks like Echo Bay Mines, Royal Oak Mines and many others which became worthless.
  • The introduction of gold ETFs such as the SPDR gold shares (GLD) created competition for gold mining stocks.  Before gold ETFs were established, investors who wanted exposure to the gold market without having to hold physical bullion would have had to invest in gold mining shares.  The GLD recently became the largest ETF by value with holdings of over $70 billion in gold bullion.

Investor preference for gold bullion and gold ETFs over mining stocks has created a vast pricing disparity between gold bullion and gold stocks.  High quality major gold producers with vast proven reserves of gold are now on the bargain table.  Gold stocks are selling at almost all time lows compared to gold bullion.   Two bargain gold mining stocks previously featured in goldandsilverblog.com are Newmont Mining (NEM) and Kinross Gold (KGC).  Investors in Kinross Gold, for example, are effectively buying gold at around $300 per ounce.

Markets can price stocks far below fundamental values, sometimes for an extended period of time, but ultimately the underlying value will be reasserted.  Gold mining stocks at this time represent immense value and are being steeply discounted.

What will be the trigger for an explosive move up in quality gold mining stocks?  Consider Glencore’s recent bids for nickel, coal and copper miners as reported in ft.com.

Glencore on Wednesday launched a A$268m (US$280m) bid to acquire full control of Minara Resources, an Australia-based nickel miner in which it already has a 73 per cent stake. Last month it offered $475m (£295m) to acquire one of Peru’s largest copper prospects, the Mina Justa project.

Industry executives said that Glencore’s latest target was Optimum, South Africa’s fourth largest coal exporter. The trading house is close to launching a bid for the Johannesburg-listed miner with the support of several South African partners, executives said.

Gold mining stocks have become  irresistible take over targets.  The first takeover bid for a gold mining company will trigger a buying stampede which could rapidly result in a doubling of gold stock prices from currently depressed levels.

Is The Plunge In Gold Stocks Predicting A Drop In Gold?

American Gold Buffalo

Gold stocks have been under performing gold bullion for the past three years.

The poor performance of gold stocks is reflected in the sub par returns of gold mutual funds run by two of the countries largest investment companies.  The three year return on Vanguard’s Precious Metals Fund (VGPMX) has actually had a negative return over the past three years as the price of gold has soared by 80%.  The Fidelity Select Gold Portfolio (FSAGX) has returned only 16.2% over the past three years. (See Physical Gold Outperforms Vanguard and Fidelity Gold Mutual Funds).

Senior gold producers such as Newmont and Kinross Gold are increasing gold production and solidly positioned for significant earnings increases but their stock prices have not been able to match the returns of gold bullion.

Although there are many reasons to expect that gold stocks will catch up to gold and deliver large gains to investors, so far this has not been the case.

Adding fuel to the investor debate over the relative merits of gold stocks versus gold bullion has been the drastic price divergence exhibited since the beginning of 2011.  While gold has held virtually all of its gains, the price of many gold stocks has plunged.  An investor in gold stocks not tracking the price of gold would probably conclude that the price of gold had collapsed during 2011.

Since January 1st, the price of gold has gained $116 per ounce or 8.3%.  From January lst to recent June lows, the price of Newmont Mining is down  by $9.27 (15.2%), Kinross Gold is down by $3.96 (20.8%) and Agnico-Eagle Mines is down by $16.01 (20.9%).  A broad basket of gold stocks, as measured by the Gold Miners ETF (GDX) has declined by $9.69 or 15.8%.

Adding to concerns about the recent sell off in gold stocks is the especially wide price divergence seen since May lst.  Although many individual gold stocks have long lagged the returns of gold, the GDX, a broad based index of gold stocks has generally tracked the price movement of gold over the past several years.  Since the beginning of May, however, the linkage between gold stocks and gold completely broke down, leaving investors to ponder the significance of such a wide divergence.

 

STOCKS VS GOLD - COURTESY YAHOO.COM

 

 

On past occasions, weakness in the gold mining shares has been a harbinger of a sell off in the gold market.  Is the current weakness in gold stocks currently forecasting a decline in the price of gold?  The end of the Fed’s money printing campaign, the world wide debt crisis, concerns about deflation, a weakening economy and the decline in commodity prices lead some to believe that a liquidity driven crisis could result in lower gold prices.

Despite short term concerns over the price of gold, the reasons for remaining long term bullish on gold are numerous.  The fundamental problems of excessive debt, debased currencies, widespread insolvency among sovereign states and out of control spending by the U.S. government all suggest that we remain on the precipice of another economic crisis.  Governments and central banks have no solutions except for the printing presses, which will be turned up to full speed at the inception of the next financial crisis.

At the margin selling may temporarily drive down gold prices in the short term, despite the solid long term bullish fundamentals for gold.  The long term trend for gold remains higher and any temporary price weakness would be a buying opportunity for gold investors.

 

 

 

Physical Gold Outperforms Vanguard And Fidelity Gold Mutual Funds

Investors in gold mutual funds have dramatically underperformed the return from holding physical gold over the past three years.  For a variety of reasons, many gold mining companies have been unable to turn higher gold prices into increased earnings.   As a result, gold stock mutual funds have dramatically underperformed the price gains of gold bullion.

Over the past three years, gold has increased by 80%, from a monthly low of $853 in May 2008 to $1,535 at today’s closing price.  Holders of the physical metal have done extremely well while investors in gold mutual funds run by two of the countries largest investment companies (Vanguard and Fidelity) have dramatically underperformed.

According to the Vanguard web site, the Vanguard Precious Metals and Mining Fund (VGPMX) has a three year average annual performance of -.46%, while the price of gold has soared 80%.  Vanguard states that although this fund is not a “pure gold or precious metals fund”, it invests in companies that are ” involved in the mining or of exploration for precious and rare metals and minerals”.  The Vanguard precious metals fund invests in 50 different stocks in 14 different countries and foreign holdings total 92% of assets.  The fund has net assets of $5.8 billion.

In early May 2008, the VGPMX reached $39 per share compared to today’s closing price of $27.20.  The fund has paid out dividends which added to the overall returns of the fund.

VGPMX - COURTESY YAHOO FINANCE

The ten year return on the Vanguard gold fund, however, would have outperformed holding physical gold.  A $10,000 investment in the Vanguard Precious Metals Fund made in May 2001, would now be worth approximately $76,300.  In May 2001, an investor could have purchased almost 38 ounces of gold for $10,000 which today would be valued at $58,330.  As noted above, the dividend payments by VGPMX added to the fund’s return.

The Fidelity Select Gold Portfolio (FSAGX) has outperformed the Vanguard fund, but still trails the three year return on gold bullion.  According to the Fidelity web site, the Fidelity gold portfolio had a 3 year return of 16.2%, compared to an 80% increase in the price of gold.

The Fidelity Fund invests at least 80% of its assets in companies involved in gold mining, exploration or processing.  The Fund also invests in gold bullion or coins and to a lesser degree, platinum, silver and diamonds.  The FSAGX has net assets of $4.5 billion.  The top ten holdings of the Fund at March 31, 2011 were Goldcorp, Barrick Gold, Newcrest Mining, Anglogold Ashanti, Newmont Mining, Kinross Gold, Agnico-Eagle Mines, Yamana Gold, Rangold Resources and Eldorado Gold Corp.  The total number of holdings of the Fund is 131.

FSAGX - COURTESY YAHOO FINANCE

The long term results of the Fidelity gold fund slightly trail the Vanguard gold fund.  Fidelity had a 10 year average annual performance of 22.54% compared to a return of 24.02% for Vanguard.   Both the Vanguard and Fidelity fund had returns that exceeded the increase in the value of gold over the past ten years.

Will physical gold or gold mutual funds deliver the best return going forward?

A continued rise in gold prices should eventually translate into higher leveraged profits for gold mining companies, unless the substantial costs of gold mining exceed the increase in gold prices.  Inflation is rapidly rising as central banks continue to flood the global economy with cheap money.  A continued rise in energy costs and general inflation could negate the benefit of increased gold prices for gold mining companies.  Investors who hold physical gold or invest in gold trust ETFs, rather than gold mutual funds, should expect to see continued superior investment performance.