Holding Gold or Bullion Stocks – What is better?
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I have recently came across many articles comparing between holding gold, either via buying SPDR Gold Trust shares (NYSEMKT: GLD)) or gold contracts, and holding gold stocks that include the major gold miners such as Barrick Gold Corporation (NYSE: ABX), Yamana Gold, Inc. (NYSE: AUY) and Goldcorp Inc. (NYSE: GG). Many of these articles compare between the performance of gold stocks and the price of gold and the fluctuations in the correlation between the two. And yet I think that most of these articles don’t consider the main factors worth considering when making this comparison.
The price of gold hasn’t done much during 2012. I suspect the bullion traders are waiting for another quantitative easing plan by the Fed that will raise the money base in the U.S and will consequently help rally bullion prices – as was the case between 2008 and 2011 when the FOMC issued QE1 and QE2 (even though we should remember that correlation doesn’t necessarily mean causation).
During the year the price of major gold miners stocks also didn’t perform well. Further, in recent years gold stocks have underperformed gold. This is also true for this year: the chart below presents the normalized prices (normalized to Jan 3rd 2012) of gold, Barrick and the S&P500. As seen Barrick hasn’t done well and underperformed not only the S&P500 but also the gold price. So bullion stocks aren't a good investment compared to gold, right? Well I think there are some considerations worth mentioning that might not make holding gold stocks a better investment than gold, but for certain companies it could tilt the scales towards them over time.
There are always risks in holding just a cretin company’s stock and one could just consider holding Market Vectors Gold Miners ETF (GDX). If someone is considering to raise his or her exposure to gold and isn't sure about the comparison between bullion companies and gold, here are some of the considerations worth noticing:
Gold stocks offer dividends that gold doesn’t: In 2012 Barrick offered a yearly dividend of $0.80 which is nearly a 2.3% yield; Yamana offered 22 cents per share that represent a 1.5% yield; Goldcorp’s dividend represent a 1.5% yield. When you hold gold, either a contract or the ETF, as you well know, you won’t get any dividend.
The comparison between gold's price and that of gold stocks should be after cironsidering the decline in gold stocks’ price due to dividend. Since these gold companies issue dividends, the stock prices are also being adjusted for it, and thus just a face value comparison between stock prices and the price of gold isn’t correct and undervalues the shares of gold miners.
Holding gold is expensive. As many of you already know, not only holding gold doesn’t payoff, in terms of dividends, but it also costs you. If you have gold, either the physical metal or contracts, it will cost you. This includes depositing margins and paying interest rates.
The performance of gold miners relies not only on their relation with gold, but also their business development (among other factors). This is something that could be good or bad. The recent rally of Barrick is due, among other reasons, to its recent business developments: The Company will start producing gold from its Pueblo Viejo mine in 2012. Barrick is expects to produce from this mine nearly 100,000 ounces of gold during this year and nearly 650,000 ounces of gold next year. This could help the company’s earnings in the near future.
Nonetheless, the company’s financials aren’t good not only because of the decline in gold prices but also due to the company’s management decisions. But if this company, or other bullion miners, will make the right decisions and increase production, then this could help rally the stocks’ performance and financial results. For example the silver producer, Silver Wheaton Corp. (NYSE: SLW) has done well in recent years and the company's decisions helped Silver Wheaton to increase its operations and sales despite the decline in silver's price in recent months.
Bullion miners tend to produce other metals which could expose you to other precious metals that are strongly correlated with gold's price. Goldcorp and Barrick produce not only gold, but also other metals such as silver and copper. The amount of such precious metals these companies produce compared to gold isn’t high but serves as an exposure to other metals and thus diversifies your bullion investment.
The correlation between gold stocks and gold prices are still strong but vary over time. During 2012 the linear correlation between Barrick and gold's price was 0.67, which is still high and strong. It means (under certain assumptions including linearity and normality) that nearly 44% of the volatility of Barrick is explained by the changes in gold price. The rest of the changes in Barrick’s stock are due to other factors related to the company’s performance as indicated above.
GLD ETF is a bit under-performing the price of gold. During 2012 GLD has underperformed the price of gold by a small margin: gold price rose by 0.4% while the price of GLD edged down by 0.2%. The correlation is still very strong and robust at 0.9 which means that nearly 80% of the variance of GLD is due to the changes in gold prices. So there is a small problem in holding GLD compared to just holding gold.
There are many factors to consider when thinking of adding gold to the portfolio. Just because the major bullion stocks haven't done well it doesn’t mean that all bullion companies aren't worth considering. The comparison isn't just in terms of stock movement vs. the changes in gold's price.
For further reading:
Gold and Silver Monthly Outlook for August
Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.
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