Time to Wake Up to Gold-Diggers

Gold mining stocks have been outperforming bullion for the first time in a while...

 

For the FIRST TIME in at least a couple of years, gold mining stock returns have been outpacing those of the yellow metal itself, writes Frank Holmes at US Global Investors.

 

As you can see in the chart below, the New York-listed Gold Bugs Index (NYSEArca:HUI) has returned 22.31% year-to-date (YTD), whereas gold has delivered 7.74%.

 

 

This is good news for both gold equities and gold bullion. When miners are doing well, gold tends to follow suit. Indeed, since the beginning of the year, spot gold has seen steady growth following a lackluster 2013. As I noted earlier in July, it's been one of the best-performing commodities of the year so far, a mere nugget's throw behind nickel and palladium.

 

Gold mining, to be sure, is a tough gig. When gold prices are between $1,000 and $1,200 an ounce, miners barely break even in terms of cash flow.

 

Last year was particularly brutal. The metal plunged 28% – from $1,675 to about $1,200 – which was the largest annual drop since 1981.

 

To reduce risk, many companies have cut costs in several ways. Some have decreased capital spending. Others have sold off assets. Others still have placed exploration on standby.

 

Case in point: One young mining company which we own in our Gold and Precious Metals Fund (USERX) has managed to shrink operating expenses from $4.4 million this time last year to $3.8 million, mostly by lowering legal and advisory expenses. Other realized annual savings have come from administration and staff reductions.

 

Another equity has performed exceptionally well this year, even after gaining 28% in 2013 as the Market Vectors Junior Gold Miners Index was down 61%. It's currently up 30% YTD and is targeting free cash flow (FCF) by the end of the year.

Royalty companies are thriving as well. They provide upfront capital to miners in exchange for a stake in future output. Since royalty companies avoid the costly rigmaroles gold miners must deal with on a regular basis – securing permits and building infrastructure, among others – they often receive a healthy return on their investments.

 

Gold might have taken a minor hit last week, but autumn is right around the corner, when the gold jewelry industry traditionally replenishes its stock. And with unrest in Ukraine and the Middle East continuing to drive the fear trade, as unfortunate as these events are, gold prices appear buoyant.

 

This bodes well not only for investors in bullion but also mining companies, which will likely proceed with cost-cutting initiatives to maintain or expand margins.