COMMODITIES

Gold miners have underperformed the metal significantly for some time now, but this just may be the time where they pull back into sensible parity with bullion, notes Gavin Graham of The Canada Report.

The price of bullion has been rising, but gold mining stocks have been lagging the price of the metal badly. Major gold miners such as Barrick (ABX), Newmont (NEM), and my recommendation Goldcorp (GG) are all down for the year.

However, the situation is changing for the better. The exchange traded fund for gold mining companies, the iShares Global Gold Index Fund (Toronto: XGD), rose 5% against an increase of only 2% for the SPDR Gold ETF (GLD). The latter fund tracks physical gold, with each share representing ownership of one-tenth of an ounce of bullion.

However, since the beginning of 2012, and over the 12-month period to mid-October, the situation is very different. Year-to-date, physical gold is up 12.3%. Over one year, it has risen 4.6%, and that period included a major slide in the price of the precious metal last fall.

By comparison, XGD is down 5.9% year-to-date and 12.9% over one year. That means the miners have underperformed bullion by 19.2 percentage points in 2012 and 17.5 points over one year.

This is not a short-term phenomenon. Over the last three years, physical gold has risen by 55%, but amazingly, gold stocks have fallen by 2%. Over five years, bullion has doubled while gold stocks are only up 10%.

The same is true for silver, where the numbers are very similar. Silver has gained 22.1% this year and 75% over three years. The one-year and five-year gains are about the same as the gold figures.

By any reasonable measure, gold stocks are selling at the biggest discount to the underlying metal for a number of years, if not decades. In August, the Philadelphia Stock Exchange Gold and Silver Index, which tracks mining companies, reached its lowest level relative to the price of gold in 28 years, according to Bloomberg data.

Several arguments have been advanced for this disparity in performance. The first, and one of the most believable, is that until the launch of GLD eight years ago, the only practicable way that investors could own gold without physically buying gold coins was to own mining stocks.

Once GLD arrived, investors who wanted exposure to gold could buy with the click of a mouse, paying very low brokerage fees rather than a premium for coins, and in some cases sales tax as well. They could then have their interest in gold bullion held in a secure vault for less than a 1% annual custodian fee.

This eliminated the costs associated with owning physical gold such as insurance and safe deposit charges. Investors were duly impressed; GLD now has more than $50 billion in assets.

Furthermore, individual gold stocks are subject to the normal costs and risks of running a mining or resource company. Expenses for labor, fuel, machinery, insurance, environmental problems, and liabilities continue to rise. Political risks include expropriation and increased taxes.

Then there is managerial risk: the possibility that senior management will make an acquisition to offset declining reserves that dilutes existing shareholders by issuing too many shares for properties that prove to have fewer reserves and resources than originally estimated. A couple of CEOs of major companies have had their heads handed to them in the past year for exactly this reason.

Tickers Mentioned: Tickers: GLD, TSX: XGD, ABX, NEM, GG