No Coattail Effect in Gold’s Surge

The price of gold has had a good increase during the first 9 months of the year largely due to the doubts over global economic and financial health. These concerns also sent stocks crashing down, including the gold stock companies themselves despite the increasing value of their main product.

By CONRAD DE AENLLE
Published: October 8, 2011
NY TIMES

IF you bought a precious-metals fund at the start of this year because you expected stock market turbulence and thought gold would be a refuge, your foresight was impressive. Your returns? Not as much.

Gold rose 14.3 percent, to $1,624 an ounce, in the first nine months of the year, including 8.2 percent in the third quarter. The price has been underpinned by persistent doubts about the economic and financial health of the United States and Europe and the measures that governments and central banks might have to take to put things right.

Those concerns also sent stocks cascading around the world. These included stock in gold companies, despite the soaring price of their main product. The XAU, a widely followed index of gold and silver mining stocks, ended September with a loss of 18.4 percent for 2011, a far worse performance than metallic gold and even worse than the 10 percent loss for the Standard & Poor’s 500-stock index.

Some of the performance discrepancy between gold and mining stocks is justified by developments affecting the metal and the companies that produce it, analysts and fund managers say. Nevertheless, they expect the gap to narrow, although they disagree on whether gold will fall or mining stocks will rise — or whether there will be some of both.

“When you buy any commodity equity, it’s not the same as buying the commodity,” Rebecca Patterson, chief market strategist at J.P. Morgan Asset Management, said to explain the divergence. “You’re going to have some correlation with the broader stock market. During the last couple of months, rather than hope for growth and a need for an inflation hedge, we have fear of a double dip. The stock portion of gold stocks is getting pulled down sharply. That doesn’t mean it’s a bad investment, just a different investment.”

Investors may buy mining stocks to get gold, but they also get businesses whose bottom lines are influenced by more than the price of what they sell.

“When you buy a company, you’re getting access to other risks,” said Nathan J. Rowader, manager of the Forward Commodity Long/Short Strategy fund. “Investors are not valuing miners as highly as physical gold because of some of those risks.”

One risk he mentioned is geopolitical: much gold happens to be located in dangerous, unstable places.

There have also been unwelcome developments on the other side of corporate earnings statements. Ms. Patterson pointed out that mine operators have been facing rising expenses of all sorts.

“Power costs are rising. Labor costs are rising,” she said. “They’re trying to increase production, but that means deeper mines and more costly mines to operate.”

Another reason for the comparatively weak showing of mining stocks, in her view, is the emergence of other vehicles for betting on gold, including exchange-traded funds that hold the physical metal. In the old days, investors who wanted to possess gold might buy coins or bars and lock them in a safe-deposit box.

Joung Park, a gold stock analyst at Morningstar, highlighted another shortcoming of mining companies that may have held back their stocks: gold in the ground is not the same as cash on the books.

“Obviously, a lot of the value for these miners is not created now, at current valuations,” but later on, when gold prices may be lower, he said. “Some investors don’t think gold prices will stay at current levels forever.” Mr. Park said he expected the metal to average $1,200 an ounce over the long haul.

He noted that many factors beyond widespread fear were supporting gold and could begin working to the advantage of mining companies. Interest rates are very low worldwide, which makes bonds and similar assets relatively less appealing alternatives. Consumers in emerging economies, often a source of robust demand for gold, are thriving. And energy costs have begun to moderate.

If these trends continued, “we would see some of the underperformance reverse” for mining stocks, Mr. Park predicted, and they would “play catch-up.”

Not that he is expecting much of a boom. His favorite mining company is Yamana Gold, a Canadian company that he expects to show significant growth as new mines start to produce. Otherwise, he said, “we think most of the miners that we cover are fairly valued.”

JOHN HATHAWAY, manager of the Tocqueville Gold fund, has much higher hopes for the sector. He sees the failure of mining stocks to keep pace with the metal as another opportunity to hop on the bandwagon — one that he expects to keep rolling along.

“I don’t agree with the cost argument because margins are the largest they’ve been in history,” he said. Another factor in the lagging returns of mining stocks, he said, “is fear that the gold price will come back substantially, but gold is different from all other commodities.” He added: “There’s no substitute for gold when you have a monetary crisis. When oil goes up, it’s because of a shortage or other macro factors, but when gold goes up, it’s because people don’t trust paper currency. What’s going to make people start trusting paper currency?”

Mr. Hathaway says that gold stocks are appealing based on the same criteria that investors use to judge stocks in most industries, and that he thinks others will come around to his view. “The generalist investor who has been burned in bank or retailing stocks, whatever, is going to look at this and think that these stocks trade at low multiples of earnings and cash flow and have high dividends compared with other stuff,” he predicted.

He prefers companies with mines in politically stable countries or at least whose mines are well diversified geographically, including two Canadian producers, Goldcorp and Osisko, as well as Newmont Mining, based in Colorado.

The weakness in mining stocks may be offering investors “a do-over,” Mr. Hathaway said. “If you missed the 50 percent rise in gold, you’ve got a second chance.”

Ms. Patterson, at J.P. Morgan, doesn’t disagree, but she sees too many uncertainties for investors to bet too much on one gold play over the other.

“We want diversification, and I don’t see that changing in the near future,” she said. “You want to own some commodities and some equities. If I were putting my own money to work right now, I would own both.”

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