Gold and Gold Miners Q4 2017

Matthew Seaward
December 29, 2017

In the present market of low inflation, low volatility and the rise of cryptocurrencies, is gold still relevant?

Although gold might not be as relevant as it once was, it still makes up a significant part of central banks’ balance sheets and maintains wealth over the long run better than cash does. Gold and silver’s solid track record as a very liquid and readily transferable tangible asset has made it a currency of last resort and the only true safe haven.

Gold investors, in the face of a rapidly changing world, tend to focus more on the strength of the global economy and are less sensitive to turmoil. Despite going through its longest losing streak in six months due to fears of a steeper-than-anticipated US interest rate path, the perceived richness of some equity valuations has enhanced gold’s attraction within the context of a diversified portfolio in our opinion.

In the quick shifting investment environment and with the continuous evolution of different, more sophisticated products, the manner in which investors attain exposure to gold becomes an important factor. There are various alternatives available to physical purchases of jewellery, bullion or coins such as exchange-traded funds, mutual funds and E-gold. These products as well as being safer than storing something (often in your house) afford much better liquidity.

The ability to sell into the strength and buy into the weakness of gold is where the returns lie. By choosing a fixed weighting of gold and rebalancing every quarter one can really take advantage of the highs and lows in the gold market. While holding gold when the price is rising might feel worthwhile and while the cost of storage or the expensive ratio of gold ETF’s is low, over the long run is it simply better to buy a gold miner that has exposure to the underlying gold and hopefully produces an enticing yield to boot?

When reflecting on the the experience of buying mining shares over the last five years, it should be noted that the gold mining sector has experienced contrasting fortunes. For example, while the share prices of Randgold Resources and Polyus have outperformed the gold price, two of the largest miners – Newmont and Barrick – have performed far worse.

Over the long term, gold equities should outperform the underlying metal, given the low valuations that investors currently ascribe to the sector. The current weighting of North American gold equities in the S&P 500 and TSX Indexes is 0.6%, having fallen from the 2% it was in 2012. Commodity equities have not often looked so cheap in relation to both the broader market and underlying prices.

Some investors might be interested to know that using simple correlation over the period between 2005 and 2017, that there is higher correlation between gold prices and the MSCI World Index than there is with gold miners; due in part to their underwhelming performance over this period. Over the next 10-20 years, gold miners as well as the broader mining sector should actually benefit from disruptions in the technology sector. Driverless cars and robotic drilling machines are already being used in mines around the world, and there have been developments in the extractions and purification of commodities. Polyus – one of the largest gold companies in Russia – has developed a bacterium as a substitute to the chemicals used to purify gold, and this development alone has led to an increase in productivity of between 30-50% over the past 10 years.

Matrix Gold miners  (GDM) World Index (MXWO) Gold spot price (XAU)
Gold miners  (GDM) 1 -0.503 0.179
World Index (MXWO) -0.503 1 0.287
Gold spot price (XAU) 0.179 0.287 1

Traditionally, a decline in stock prices is accompanied by an increase in gold prices, making it a hedge against stocks. One of the historical reasons for this is the fact it possesses properties not shared by its competing assets, for example, it is a highly stable metal and the annual mined production forms a trivial share of the total stock of gold outstanding. A plethora of research has been devoted to testing the relationship between gold and other macro financial variables such as inflation, exchange rates and stock markets. On assessment, these research papers appear to overall conclude that gold and stocks do not seem to move together.

However, there were no significant movements witnessed during crisis periods, and this indicates that gold is a weak hedge against a diversified portfolio. Some researchers have argued that gold hedging properties depend on the magnitude of the depreciation or the move in the market.

To be successful at investing in gold miners it is important to invest at an early stage, or at the very least, select miners that are investing in new prospects. It could be suggested that the returns are found in the prospect before it is priced fully into the share price while the actual mining is just noise. However, if one’s risk appetite is low and the prospect of reading endless miner reports is unappealing, a low cost physical gold ETF is certainly the way to go.

Continue reading