Gold mining stocks seem to be at bargain bucket prices at the moment. We often hear that gold miners outperform gold and provide leverage to the gold price but is this really true? Here we look historically at the gold mining stocks versus physical gold and aim to answer the following three questions:
- Which has been the most profitable investment so far?
- Why is this the case?
- Which of the two assets has the best future potential?
How have gold mining stocks performed historically?
The AMEX gold BUGS index (HUI) is a basket of unhedged gold stocks and includes 14 major gold miners. The chart above directly compares HUI to the gold price from 2004 to present scaled as percentage change over that time. From 2004 up until 2008 prices tracked pretty closely to each other (i.e. neither assets outperformed each other, they performed equally well). However in 2008 there was a 30% drop in the gold price whereas the HUI index dropped over 70%. Certainly the gold miners outperformed gold…but to the downside. After 2009 the gold price shot up and made new all-time highs. However although the gold miners also rose, they didn’t rise nearly as much and they barely exceeded their 2008 peak. In this period of time, although we had a nice strong bull market in gold, the gold miners just didn’t excel but instead underperformed gold.
The bear market in gold beginning in 2012 saw a sustained drop in the gold price. However the gold miners dropped much further and in fact fell below the 2009 levels. Currently, the HUI index is at pretty much the same level as it was in 2004 whereas the gold price is significantly higher than it was in 2004.
Above is shown the HUI index chart but instead of being expressed in US dollars, it is expressed in terms of gold. The numbers on the Y axis indicate how many ounces of gold it takes to buy one share of the HUI. A low number means that the gold miners are cheap relative to gold whereas a higher number means that they are more expensive relative to gold and the historical average is 0.32. A move in the upwards direction means that the miners are outperforming gold to the upside, whereas a downwards direction of movement means that the miners are outperforming gold to the downside. The steeper the line means the greater the outperformance.
Since the 2004, the gold miners have been outperforming gold to the downside as the general direction of the trend. In 2016, this ratio reached an historical low. We are just above that low now but the interesting thing here is that 2018 saw a break out from the downwards trend line. This suggests that a trend change is about to occur. There are a few possibilities from here. One possibility is that it can come back down and retest that trendline and so we might revisit the lows of 2016 but remember this ratio can never go to zero. In order for it to go to zero you would either have to have gold go to zero (which it has never done in 5000 years of history) or the gold miners would have to shut up shop and just stop mining gold because of either bankruptcy or because it’s just not worth doing business. This seems unlikely, particularly if the demand for gold is high and the price of gold increases. The HUI index is getting pretty close to about as low as we can get. That makes it an asymmetric trade.
The chart above shows the Barron’s gold mining index (BGMI) to gold ratio dating back to 1940. Historically, the gold miners were stable relative to gold for two decades. Coming into the 1960s, there was a sharp rise with the miners outperforming gold significantly but then the gold miners dropped off before the bull market in gold started. Remember that gold was only freely traded since 1971 and the yellow boxes indicate the bull market in gold prices.
Interestingly the gold miners actually did poorly relativity to gold during that bull market. The other big bull market in gold was in the 2000s and again the gold miners had a very lackluster performance relative to gold. Interestingly we are currently below the 1940s level. Therefore, relative to gold, the gold miners are cheaper than they have ever been historically.
All the preceding charts represent the major gold miners but what has been happening with the juniors and the explorers? The following charts split up the three classes of gold miners.
Australian gold producers
The Australian major gold producers index above shows how the prices of these miners have oscillated backwards and forwards since 1995 within a wide trading range. Currently, they appear to be reasonably cheap.
The chart for the Australian junior gold miners looks rather ugly. There was a massive boom in the early 1990s but since then price has never recovered from that and prices flat lined from 2013.
The situation for the gold explorers is even worse. The overall trend has been downwards and now we are getting pretty close to zero. The gold explorers have clearly suffered the most.
Why have gold miners been hammered so much over the decades?
There are a few possible reasons for gold mining stocks being so down trodden. The first is the introduction of financial instruments such as leveraged gold ETFs and ETNs, as well as options and futures contracts. These instruments provide leverage to the gold price directly without having to have the added risks that come with the mining industry. There has certainly been a huge uptake in leveraged instruments instruments as they are very convenient and are highly liquid. Another factor is serial stock dilution from capital raisings which has put downwards pressure on some gold and silver mining stocks. Also there are other, trendier, sectors (e.g cryptocurrencies, technology sector, and marijuana stocks) that are siphoning money away the speculative money that would have ordinarily gone to mining stocks in the past.
Will we have another gold mining boom?
……or is this trend just going to continue with particularly the explorers dying off over time?
If we want to see another mining boom then I think there are a few things that need to happen.
Firstly we need a good strong bull market in gold which will certainly help, but remember that we have had bull markets in gold in the past and the miners had not necessarily done so well during those periods. We therefore need a few other factors to come into play. A catalyst might be a bursting of many of the asset bubbles which could potentially bring money into the gold mining sector. This would particularly be important if institutional investors come in and of course the boom will be in full swing once we get more retail involvement.
There is light at the end of the tunnel for the gold mining industry but it is clearly still important to hold physical gold.