Why Gold Mining Stocks Have Lagged Behind Bullion

Investors used to pay a premium expecting Gold Prices would rise. That premium is now much smaller...

OVER THE last ten years Gold Prices have risen steadily. But, the share prices of Gold Mining companies have had a far less steady run, writes Geoff Candy at MineWeb.

A good example of this is the changing fortunes of the constituents of the Market Vectors Gold Miners ETF. The ETF, which is listed on the NYSE and designed to replicate the NYSE Arca Gold Miners Index, had, until 18 months ago, strongly outperformed in relation to physical gold.

Since then, however, it has posted a rather poor performance.

In a note to clients, Hallgarten and Co. mining analyst Christopher Ecclestone, looks at the performance of the ETF and posits some reasons why this may be the case.

The first reason is the anomalous presence of a number of silver stocks in the index which has dragged performance down since silver prices were pulled back to earth in May and exacerbated the gulf in performance between the ETF and physical gold.

This and a number of strange inclusions, such as Seabridge, which has claimed never to own a mine and exclusions such as Midway Gold, mean that the index perhaps hasn't done quite as well as possible.

That said, however, the main reason Ecclestone posits for the underperformance is the top heavy nature of the index.

As he explains: "In its most recent iteration, the top five names make up 45.5% - down from as high as 50.32% at the end of 2009 – showing that juniors and mid-tier golds started to catch investors' imaginations as interest in gold proxies waned."

Ecclestone adds: "While not surprising that any index weighted by market cap should be dominated by its largest members, in this case the number of horses pulling a very large wagon is very few. The value of most holdings has risen but the top group (despite their ponderous weightings) have not moved all that much."

This loss of investor attraction to gold proxies has a number of explanations but two in particular are worth mentioning.

The first, not mentioned by Ecclestone, is the changing outlook for large Gold Mining stocks given the strong rise in prices seen in recent years.

He said, "If you look at the long term trend – if you go back to the start of this bull market about 10 years ago when gold was more abundant – sitting at $280, large gold stocks generally carried PE ratios in the 30 range which was quite high in relation to the rest of the market. 

At those Gold Prices, people were buying the reserves if you will – they were paying a premium to get a call on a higher Gold Price. Now that gold has gone to almost $1,500 that premium that people are willing to pay for the call on higher prices is getting smaller and smaller."

Higher margins and increasingly difficult deposits, many in riskier areas than in the past, have also contributed to the a shift by investors into other types of gold exposure.

Ecclestone is one of those investors, writing: "Frankly we would be in the camp that prefer physical over equities mainly because the equities just seem to be such a poor alternative to the physical due to lacklustre managements and a lack of focus."

He adds, "It is often commented amongst gold watching professional investors as to how the managements of the gold majors are so mediocre. Big dumb and happy seem to be the watchwords for the big gold players. 

When an overpriced acquisition is made the investors just shrug their shoulders as if "what else should you expect" from the largest players...the result is that Big Gold names are seen as lackadaisical at best and thus it is no surprise that investors should be steering towards the more tangible holdings of the physical gold ETF rather than pursuing 'lookalikes' that are not looking alike in performance let alone any other attribute of similarity that can be imagined."

Clearly, the gold majors have been losing their way a little when compared to the physical metal, the big question is whether or not they can regain their footing?

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