(By Costa Bocelli) Gold is having an identity crisis of late.
Some days it behaves like the safe haven asset and hedge against fiat money dilution we're used to. Other days, it's behaving more like a risk asset, moving in conjunction with the equity markets.
Either way, since Gold topped out around $1900 an ounce last Fall, it has indeed been in a downward trend. While the pullback has been quite significant, Gold does look like it's finally trying to put in a floor around $1550 an ounce, having tested and held that level several times this year.
At the same time, it hasn't exactly been able to break out either, encountering resistance at around $1650 an ounce. Its range bound price action and its day to day unpredictable mood has been very confusing for many investors.
While Gold may have temporarily lost its way, there are still many factors in place that continue to paint a bullish picture looking forward.
Interest rates are currently below inflation, and there's no hint that they will be raised anytime soon. Central banks continue to flood the markets with unlimited liquidity against shoddy collateral to prop up the banking system, and more money creating QE is coming down the pike from the United States, Eurozone, Japan and the United Kingdom.
That being said, and no matter how bullish the environment is for gold to move higher, price action is the ultimate truth, and it hasn't quite been coming to fruition of late.
Over the past six weeks, gold prices are up roughly 3% from May's low.
But what about the Gold mining stocks over that same period?Are the Gold Miners the Way to Play the Upside in Gold Right Now?
I know what you must be thinking: Gold Miners? Are you kidding? They've been getting killed relative to the price of Gold.
Let me explain...
You would be correct in that argument... depending on the context of your time frame. It's true that the gold miners have had a tough time over the past year-plus, and have not exactly been "worth their weight in gold".
Many investors, including myself, have been too early (and perhaps too often) trying to scoop the gold miners over the past year as a bullish play on gold.
But just because a trade or investment strategy didn't quite work out as hoped in the past, doesn't necessarily mean that it can't work orbe the right move sometime in the future.
As investors and personal managers of our own money, it's our job to learn from our mistakes, always keep an open mind, and look for or recognize new opportunities, even in securities that may have not worked in the past.
And what we have seen over the past six weeks is indeed a recognizable shift -- a shift of relative strength between physical gold prices and gold mining stocks.
In fact, over the same six week period where gold prices are up about 3%, the gold miners have outperformed sharply and are up nearly 13%!
Why is this so?
First, while gold miners have lagged the performance of gold in the longer term, they are after all levered to the price of gold and to the size of their proven gold reserves in the ground. The correlation can only diverge so far before the market will force the connected relationship towards the mean.
And that is what we're seeing right now -- a huge divergence that has capitulated. And that divergence is still historically wide right now, meaning that gold miners should continue to relatively outperform physical gold prices.
Second, the gold miners have been unduly punished with the rest of the general mining space. Slowing global growth and recessionary fears have hit industrial miners particularly hard, as demand and pricing power have been drastically reduced for iron ore, coal and other industrial materials. Many of these miners are lumped together and sold as an entire group by big fund and money managers when they unload.
The daily chart below shows the relative strength of physical gold prices to gold miners. The chart is an overlay of GLD (an ETF that tracks physical gold prices) to GDX (an ETF that comprises a basket of major gold producers).
Aside from the fact that the divergence between gold prices and miners is still significantly wide, there are two other distinct reasons why the miners should continue to relatively outperform.
One, oil prices have plummeted. In the past two months oil prices have come down nearly 25%, which is a huge boon for the miners. The reduction in energy prices, which is a major input cost, should be a favorable tailwind pushing up profit margins and earnings. The second quarter is coming to an end and management will most likely highlight the benefits and major savings in reduced energy costs when they next report.
Two, risk free interest rates are hovering near all-time lows. Longer dated US Treasuries and German bunds, deemed safe haven securities, are both yielding less than 1.6%. This places a huge premium on risk assets that distribute dividend income and offer yield to investors.
Not only are investors looking for yield, but holding physical gold or a physical gold ETF like GLD yields ZERO.
Many major gold miners have attractive yields at their current offering prices, which is a compelling bonus. Newmont Mining (SYM:
NEM) yields 2.9%. Barrick Gold (SYM:
ABX) yields 2.1%. And, Yamana Gold (SYM: AUY), which just announced another dividend hike, will now yield 1.7%.
All of these miners currently have dividend yields greater than the US ten year Treasury Bonds.
The bottom line is that market conditions and global monetary policy continue to look favorable for bullish gold exposure, but the gold miners, and the gold mining ETF GDX in particular, finally look poised to relatively outperform and outshine the physical metal -- at least for now.