In the last year gold (shown below as the ETF NYSE:GLD), has been up 25% more than NYSE:GDX, an ETF basket of gold stocks. There have been many reasons for this. Miners have had:
- higher energy costs – mining costs have a high proportion of fuel costs,
- more regulation,
- higher taxes,and
- higher cost of maintaining permits – as well as permitting out new mines, and
- marginal reserve extraction costs are higher.
- New gold mines generally have higher costs for infrastructure and permits.
Will this divergence reverse? Many pundits have suggested this divergence is like a rubber band – and at some point the gap will close.
The divergence between gold and gold miner stocks is shown on this one year Yahoo chart:
With spot gold selling more than $1,700 an ounce one would believe miners should be doing very well. However, the spot price does not reflect directly on the miners. Miners do not sell significant amounts of gold on the spot market – some enter into future contracts at a set price, while others negotiate with major buyers near the time the gold production can be delivered. In either event, miners’ production is generally sold at prices below the spot price.
Another factor is that production costs are not fixed. As the price of gold improves, many miners are able to mine previously unprofitable areas. In other words, the higher gold goes – generally the higher gold production costs will go.
Each mining company has its own cost basis and as a result mining companies can very greatly in profitability. This means that stock selection can have a major impact on investment return.
The above graph shows that in 2011 has shown gold miners acting somewhat like broad stock indices such as the Russell 2000 (^RUT) and the S&P 500 (^GSPC), while gold (GLD) has a mind of its own. However, so far in the new year gold miners are performing nearly as well as gold.
Gold Miners are simply manufacturers and, to a large degree, act like any other manufacturer in balancing profitability and costs. It is unlikely that miners as a group will outperform gold going forward. Note that this is a generality, as each miner is different and some lower cost producers could do very well.
I love miners – and traders can profit by riding the volatility, and identifying outstanding performers. Gold miners are too varied to be grouped and bought in a single ETF such as GDX for a reasonable return. My future posts will suggest possible moves to profit with specific miners.