Gold vs. Gold Stocks

Buying Gold keeps beating gold-mining stocks for investment returns...

THE SUMMER DOLDRUMS for gold investors came to an abrupt end in September, writes Brad Zigler at Hard Assets Investor, as the yellow metal broke – and stayed – above the $1,000 mark.

Gold's latest move has stoked the long-standing debate between mining stock aficionados and bullion fans. What's a better investment – Gold Bullion (or its proxies) or Gold Mining shares?

The answer to that question can easily vary, depending upon your time frame...

For example, look back to the 2006 introduction of the Market Vectors Gold Miners ETF (NYSE Arca: GDX), a portfolio of nearly three dozen global mining companies; you'll find bullion earned a substantial investment advantage over equities. Since 2006, the SPDR Gold Shares Trust (NYSE Arca: GLD), which represents an undivided interest in bullion, has racked up a compound annual growth rate (CAGR) of 13.1%, while the GDX portfolio has grown at an annual rate of 7.3%.

On a year-to-date basis, however, the situation is vastly different. Even with the recent breakout move, bullion's performance lags that of mining shares in 2009. GLD shares have gained 15.5% vs. GDX's 41.5% appreciation in Dollar terms.

This shouldn't be surprising. After all, commodity stocks have led physicals this year. Take, for instance, the outperformance of the Market Vectors RVE Hard Assets Producers ETF (NYSE Arca: HAP) over the GreenHaven Continuous Commodity Index Fund (NYSE Arca: GCC). The HAP portfolio, comprising global equities, is up 35.1% this year, while the futures-tracking GCC fund has risen just 10.3%.

An even more dramatic disparity developed between the stock-based Market Vectors Agribusiness ETF (NYSE Arca: MOO), which jumped 44.2% year-to-date 2009, and the futures-based PowerShares DB Agriculture Fund (NYSE Arca: DBA), currently 2.8% under water.

Like other commodity stocks, the strength of Gold Mining shares depends, in part, upon the health of the broader equity market. A buoyant environment for stocks, at least, is wind at the back of gold shares. That's pretty much reflected in the price ratio of GLD shares to those of GDX.

For the first year after the GDX portfolio was launched, GLD shares traded at an average 1.6-times multiple to GDX. Then, as 2007 segued into 2008, equities wobbled and collapsed, propelling the GLD/GDX ratio higher, as physical gold was sought as a safe haven. The ratio ultimately peaked in October 2008 at 4.4-to-1, before sliding to its present 2.1-times multiple.

When comparing Gold Bullion with gold stocks, of course, we must remember that funds such as GDX represent a portfolio of individual stocks, so the question of mining shares' strength necessarily must be resolved by comparing each issue to bullion and to its equity peer group.

The top 10 issues in the GDX portfolio comprise two-thirds of the fund's capitalization and thus have a disproportionately large influence on its performance. These are, in order of size, Barrick Gold Corp. (NYSE: ABX), Goldcorp. Inc. (NYSE: GG), Newmont Ming Corp (NYSE: NEM), Kinross Gold Corp. (NYSE: KGC), AngloGold Ashanti Ltd. (NYSE: AU), Gold Fields Ltd. (NYSE: GFI), Agnico-Eagle Mines Ltd. (NYSE: AEM), IAMGOLD Corp. (NYSE: IAG), Compania de Minas Buenaventura S.A.A (NYSE: BVN) and Yamana Gold, Inc. (NYSE: AUY).

We can compare these issues for their individual performance on the basis of their CAGR over the past three years, as well as their reward-to-risk ratios, which quantify the return generated for each unit of risk undertaken over the period.

Metrics such as beta and r-squared correlations can offer insights on stock performance relative to market benchmarks. Beta describes the variance in a security's price compared to that of Gold itself and the GDX portfolio. A beta coefficient of 1.00 indicates a direct and equal degree of price volatility with the benchmark. Readings above 1.00 signal a more volatile stock, while readings below 1.00 bespeak less variance.

The r-squared correlation, on the other hand, indicates how much of the stock's price action can be described by that of Gold (here represented by the gold-proxy ETF, the SPDR trust fund) and GDX benchmarks. An r-squared value of 1.00 indicates the stock's price trajectory could be imputed solely to the benchmark, while readings below 1.00 allow varying degrees of influence by other factors.

Like correlation coefficients, lower r-squared values denote dissimilarity.

Benchmark Gold Performance (23-May-06 To 16-Sep-09)
	CAGR	Rew/Risk	Beta (GLD)	R-Squared (GLD)	Beta (GDX)	R-Squared (GDX)	Weight (GDX)
GDX	7.3%	0.13	1.66	0.58	--	--	--
GLD	13.1%	0.53	--	--	0.35	0.58	--
ABX	6.6%	0.12	1.71	0.56	0.85	0.83	12.1%
GG	10.7%	0.17	1.86	0.54	1.06	0.84	11.4%
NEM	-2.5%	-0.05	1.41	0.47	0.83	0.78	8.4%
KGC	25.4%	0.38	1.91	0.49	1.11	0.80	5.8%
AU	-1.5%	-0.02	1.37	0.29	0.93	0.65	5.7%
GFI	-9.7%	0.15	1.61	0.36	1.03	0.70	5.0%
AEM	25.9%	0.40	1.90	0.52	1.09	0.81	4.9%
IAG	17.7%	0.28	1.63	0.40	0.95	0.67	4.8%
BVN	7.9%	0.11	1.57	0.32	0.95	0.56	4.7%
AUY	6.5%	0.10	1.98	0.52	1.11	0.79	4.4%
Average (gold stocks)	8.7%	0.13	1.70	0.45	1.00	0.79	6.7%

Collectively, mining shares produced about half the annual growth of Gold Bullion over the past three years. Still, certain issues such as Agnico-Eagle, Kinross Gold and IAMGOLD Corp. generated outsized gains and, accordingly, earned the highest reward-to-risk ratios.

It's not surprising to see high beta values for the best-performing issues, although high volatility isn't necessarily a guarantee of big gains. Yamana Gold, for example, exhibits the highest beta against gold, but only cranks out a middling growth rate.

As a class, mining shares are clearly more volatile than gold. Sometimes, their higher risk yields compensatory rewards and sometimes not. Reward-to-risk ratios for half of the miners are below that of GDX or the miners' peer group.

Note, too, that gold's return attribution, represented by each issue's r-squared correlation to GLD, is fairly weak. This indicates that gold's influence in the stock's return lags the impact of other, more intrinsic forces.

So plainly, an investment in Gold Mining shares is not the equivalent of Buying Gold for investment. Additional layers of risk are heaped upon gold in a stock investment, and they require careful analysis. Sometimes, undertaking those risks pays off handsomely in double-digit excess returns, but from what we can see over the past three years, that's more the exception than the rule.

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