Since its recent peak in early August, the price of gold is down a bit. The shares of gold mining stocks are down a lot more. Are gold mining shares going to play catch-up – or does it often happen that the price of gold, and the price of gold mining shares, seem to exist in different worlds?
I think that for most investors, owning gold makes a lot of sense. It’s one of the best hedges against market volatility. When markets fall, gold prices normally head higher, and gold is great insurance. In a world of zero, and negative, interest rates, one of the big objections to owning gold – that it doesn’t pay dividends and that it costs money to store it – evaporates. And there’s a strong argument to be made that gold could rise a whole lot from where it is now, especially if the world’s central banks continue to debase fiat (that is, paper) currency.
No asset moves up in a straight line, of course. And gold has been treading water for a number of weeks.
Gold and gold mining companies
The shares of gold miners – companies that take gold out of the earth – are linked to the price of gold. But gold mining is a difficult business. The main revenue driver, the price of gold, is out of the control of the gold mining company. And costs – personnel, equipment, and the hugely expensive mining operations – don’t change much regardless of the price of gold.
That means that a gold miner can easily go bust when the price of gold falls below, or close to, its cost of production. But when the price of gold rises, the profitability of gold mining companies rises dramatically – because their costs are roughly the same. (This is called operational leverage.)
That’s been reflected in the share prices of gold mining companies since the price of gold hit its recent low in December 2015. Since then, it’s up 27 percent. Gold miners are up a lot more, in anticipation of much higher profitability.
The largest gold mining company ETF, the VanEck Vectors Gold Miners ETF (New York Stock Exchange; ticker: GDX) is up 104 percent since then. (Some of its biggest holdings include gold mining giants Newmont Mining Corp, Goldcorp and Barrick Gold.)
And the VanEck Vectors Junior Gold Miners ETF (New York Stock Exchange; ticker GDXJ) of smaller (“junior”) gold mining companies is up 150 percent (its largest holdings include B2gold Corp, Alamos Gold and Hecla Mining Co).
This works both ways. Since the price of gold hit its most recent high on August 2, it’s fallen just under 3 percent. But GDX is down 14 percent, and GDXJ has fallen almost 9 percent. And that’s just the index – the shares of some gold mining companies are down a lot more.
Gold mining shares and gold prices in recent history
That kind of volatility is normal for gold mining companies. GDX’s share price hit a low of US$15.62 per share in October 2008 and gold prices were at US$741 an ounce. Then gold prices climbed to US$1888 by August 2011 – a 155 percent gain. But GDX climbed to US$61.35 per share – that’s 293 percent higher.
Then from August 2011 to December 2015, gold prices dropped 44 percent to US$1050 an ounce. But GDX’s price fell 78 percent to US$13.23 a share.
The junior miners tell a similar story. GDXJ has only been trading since the end of 2009, so it doesn’t have that long of a track record. But when gold prices fell from their peak in August 2011 to the lows reached in December 2015, a 44 percent drop, GDXJ fell more dramatically. In August 2011, GDXJ reached US$130 per share. By December 2015, its shares had dropped to US$18.65 – a collapse of 86 percent.
Gold and mining companies’ correlation
Gold and gold mining shares have a relatively high correlation, meaning they move in the same general direction most of the time. The closer the correlation is to 1, the more in unison two different assets move. As the correlation coefficient approaches negative 1, two assets tend to move in opposite directions.
The table below shows the correlation between GDX and GDXJ, and the price of gold. The correlation has been stable over a range of time periods, as shown below.
But the share prices of gold miners are a lot more volatile than the price of gold. When gold catches a cold, gold miners develop a deep cough and have difficulty breathing. And when investors are concerned about what the U.S. central bank is going to do, the shares of commodity-related stocks can get hit hard.
Will the shares of gold mining companies bounce back? If the price of gold remains strong, they probably will. This might be a case of mean reversion – the price of gold, and the share prices of gold miners, won’t diverge for long, as the long-term correlation between them reflects.
Owning plain old gold is still a good idea for everyone’s portfolio, though. One easy way to do this is through the SPDR Gold Shares Trust ETF (code O87 in Singapore; ticker GLD on the New York Stock Exchange) or the Value Gold ETF on the Hong Kong exchange (code: 3081). Or, if you want a bit more volatility – both up and down – look at GDX or GDXJ.