Why Gold Miners Fell Off the Fiscal Cliff?

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Wednesday’s trading session saw a somewhat uncommon divergence between gold and the stocks of the major gold miners. Using the SPDR Gold Shares (NYSEMKT: GLD) as a proxy for gold and the Market Vectors Gold Miners ETF (NYSEMKT: GDX) as a proxy for the miners, GLD was up 0.02% during the day, and the GDX shed 4.56%. While the long-term correlation between these two highly connected markets is lower than one might think, periods of recession tend to produce the most significant disconnects (see chart below – shaded areas represent periods of recession).

<img src="http://media.ycharts.com/charts/f5eb4172bbc7e7e28883828b384f7263.png" />

GLD data by YCharts

As the true severity of the divide that is carrying us all towards the edge of the fiscal cliff becomes ever more apparent, the shiny yellow metal is acting as expected – as a safe haven – while the miners have thrown in with stocks in general. Stocks have been hurt because, as most experts agree, the lack of resolution of the central issues involved in the fiscal cliff are likely to lead to another economic recession. While I believe that there is the potential for further downside for the miners, these declines, particularly surrounding weak earnings, represent a significant long-term buying opportunity.

The Economic Landscape

The current state of affairs for the economy is not particularly promising. Europe remains in turmoil, China has not quite gotten back on track, the U.S. Government continues to face a series of spending cuts and tax hikes (the fiscal cliff), and the Fed is promising to keep stoking the printing press fire. With President Obama vowing to fight any tax relief – which is really the continuation of existing tax relief – for the “rich,” Fed Vice Chair Janet Yellen said on Tuesday that she expects to keep rates near zero into 2016, extending that zero rate period by six more months. As the presumptive heir apparent to “Helicopter” Ben Bernanke’s top spot, the message is clear: inflation is inevitable.

The 2008 Recession

The last time there was a deep economic recession, there was also a significant divergence between the investment performance of gold and of the gold miners. From June to December 2008 (see chart below), gold outperformed the miners by roughly 35%. This is important to note because this type of divergence can be severe and last for an extended period of time. When this phenomenon reversed, however (see second chart), the gold miners outperformed gold by nearly 70%. As we all know, past performance is not a guarantee of future results, but understanding these characteristics of the relative strength between these two types of investments is important.

<img src="http://media.ycharts.com/charts/95cb66d50f81f1b65f2a8a26effcfe6e.png" />

GLD data by YCharts

<img src="http://media.ycharts.com/charts/44913558f95698db07e63ada1202e836.png" />

GLD data by YCharts

Choosing an Allocation

With most of the major gold miners, which are also significant components of the GDX, through earnings – including Barrick Gold (NYSE: ABX), Goldcorp (NYSE: GG) and Newmont Mining (NYSE: NEM) – certain choices are stronger than others. Barrick is cleaning up its balance sheet and adopting a more disciplined approach, Goldcorp trades at a premium to Barrick but a discount to Newmont, and Newmont has the most attractive PEG ratio at 0.19. Ultimately, while Barrick tends to be my preferred gold investment, as a macro bet, the ETF holds a certain appeal.

Against the combined catalysts of increased inflation expectations and the looming fiscal cliff, gold continues to look very strong heading into the later part of the year. As debate over the fiscal cliff intensifies, and recession fears mount, the miners may continue to perform as stocks rather than commodities proxies. This divergence will create a significant buying opportunity, but you should be sure you have both the capital and emotional fortitude to weather the storm if the disconnect persists. Ultimately, the trade should yield very positive result, but it needs to be carefully managed.

Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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