It’s
probably the #1 question on every gold investor’s mind right now: Why
are gold stocks underperforming gold? Aren’t they supposed to bring us
leverage to the gold price?
Yes, they are, and their performance been both disappointing and
puzzling. There are some exceptions, to be sure, but in the majority of cases
the stocks are lagging the metal. And it’s been happening for most of
the year. What’s going on?
I think part of the answer lies in the state of our current
environment. Recent headlines and developments around the globe have
ratcheted up fear… from the S&P’s downgrade to European bank
solvency, from fears of another recession to worse-than-expected
unemployment. The nervous climate has pushed investors toward gold for safety,
simultaneously reducing the demand for gold equities.
You don’t say, “Hey, I need a new iPad!”
when you live in hurricane alley and a storm is coming. You make sure
you’ve got protection for your family. Likewise, fears of
Europe’s debt problems ruining their economy don’t exactly make
investors run out and buy Barrick. They buy gold.
First, let’s get a handle on how gold producers are performing
relative to the metal. Here’s a chart that logs the weekly performance
of GDX (the Gold Miners ETF) in relation to GLD (the metal ETF). Positive
numbers represent the percentage by which GDX outperformed gold that week;
negative numbers signal how much it underperformed the metal.
As you can see, while there have been periods this year when gold
stocks have outperformed the metal, roughly half the time they haven’t
kept pace with surging gold prices. This is not the picture of an asset
that’s supposed to bring a leveraged return to gold.
So what’s going to move them? If I were a physician and gold
stocks were my patient, I’d say, “Take two catalysts and call me
in the morning.” Like some of these…
Less Fear, More Greed: We probably
need a shift in the investing climate before gold stocks excel like we want
and expect. An environment full of fear will draw investors toward safe
havens and away from stocks. We don’t necessarily need a “roaring
twenties” type of atmosphere (though that would help); we just need one
where there’s a lack of constant bad news. Once investors feel the
sharks have left the beach, they’ll be more apt to look for ways to
gain a higher return than metal can bring.
What if Doug Casey is right about a Greater Depression,
and fear is high for years? I think the better gold stocks still outperform
in that environment. For starters, investors may fear that other assets won’t
make much money; this has been the case with the S&P this year… and
bonds could be next. A shift into stocks could also take place when inflation
turns higher, as investors scramble to earn a higher real return. Last,
history has shown that the natural progression is to move from the metal to
the equities in a bull market. I think that’s our future, sooner or
later.
Keep in mind the good news here: The gold you own is performing
exactly as it should be in response to current events. We own gold for
protection against the very things for which it’s supposed to provide
shelter: failing currencies, lagging economies, and fear of inflation. This
is proof that holding gold has been the right call and will continue to be
the right call for the foreseeable future.
I don’t know when the shift from fear to greed will take place,
but I’m convinced it will. And I suspect that the change in sentiment
could be sudden.
Competitive Dividend Yields: Many gold
companies have increased their dividend payments over the past year. In fact,
every gold producer in the BIG
GOLD portfolio except one has initiated or increased its dividend
this year, many of them several times. Growing dividends could raise the
eyebrows of investors and broaden the investor base.
That said, this is not a catalyst that will
kick in next week. The current dividend yield of the gold industry is 0.75%
(GDX is 0.70%); while this is up significantly since 2001, it is still less
than half the S&P average of about 2.0%. However, as yields approach the
levels of the broader market, institutional investors will be drawn to our
little sector. Gold stocks could become core holdings, opening the door to an
entirely new audience of investors. That’s a group that could light a
fire under prices.
Governments: The CME hiked margin requirements on gold twice
recently and five times on silver earlier this year. At some point a hike
could be one too many, prompting investors to slow down on gold and turn to
the undervalued equities to capture bigger returns. Another catalyst could be
a government announcing they’re lowering
tax rates on miners – a shock in the current rapacious environment that
could see new money pour into the sector overnight.
The Usual Suspects: The usual sparks could ignite
interest in gold stocks: a company announcing a large gold discovery… a
sudden or unexpected surge in inflation… the gold price soaring 20%
overnight due to some world-changing event... the public recognizing the
potential in gold stocks and not just gold. Or how about a well-known
investor or analyst outside the gold industry announcing he’s buying
gold stocks? Could you imagine the impact on our tiny sector if, say, Warren
Buffett declared he was adding gold companies to his portfolio? (He’s
not exactly pro-gold, but you get the idea.)
I’m not saying any of these things will come to pass or are
imminent. There are certainly other potential catalysts, too. My point is
that sooner or later investors will be drawn – or perhaps even forced
– into buying gold stocks.
The investment implications here are twofold. First, if I’m
right, then the strategy should be to buy when shares are relatively cheap
and hold for the duration of the bull market. You may think we’d suffer
“opportunity loss” if we have to wait too long, but that could be
a dangerous game; you could buy after they take off and miss out on some of
the easier gains. Further, I don’t know of another sector that is both
cheap and imminently poised to break out. The second implication is that
corrections wouldn’t be a time to get out, but a time to consider
getting in.
The ultimate prognosis, in my opinion, is that gold stocks are headed
much higher. Sooner or later a catalyst will ignite interest in our sector,
and the rush will be on. Now is the time to build positions in the stocks you
want to own.
[Just how cheap are gold stocks
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