Are Gold Miners the Best Way to Tap Gold?

by James Brumley | August 10, 2012 8:58 am

“Common knowledge” can be funny sometimes in that it’s not always accurate. That reality also exists in the investment world — some of our most treasured trading axioms also are flat wrong.

Trouble is, how do you know which ones to trust and which ones not to?

Answer: You test ‘em. Of course, if you’ve done your test right, you have to accept the results for what they are, like them or not.

One axiom has been bugging me of late: the assumption that gold miners are the better way to invest in gold, especially when the price of gold is rising.

The gist of the idea is simple enough. Regardless of the current price of gold, the cost of digging up gold is relatively static. In other words, whether gold is trading at $1,700 per ounce or $900 per ounce, it costs about $650 in cash — on average — to go dig it up. Ergo, a decent-sized increase in the price of gold can mean an explosive surge in miners’ margins.

That’s the theory, anyway.

Maybe it’s just me. Maybe I just happen to be watching the wrong gold miners. Perhaps I’m just imagining things and the major gold miners actually are doling out reasonable rewards compared to the raw commodity’s price. Or, maybe we all need to forget about trying to pick the red-hot miner and instead just step into the SPDR Gold Trust (NYSE:GLD[1]) or open a futures account and buy some long-term gold contracts.

Charts Don’t Lie

Although gold has been hot since 2001 when it started its meteoric rise from $261 per ounce then to the late-2011 peak of $1,887, the euphoric aspect to gold really didn’t materialize until gold regrouped at $700 per ounce in late 2008. That’s when traders caught gold fever, but by early 2009 I started to sense more and more lethargy among the miners at a point in time when rising gold prices should have been driving these stocks through the roof.

Click to Enlarge
Was I crazy? Check out the nearby chart and see for yourself. Since the beginning of 2009, gold prices have improved by 85%, but only two of the biggest 11 gold mining stocks out there — Randgold Resources (NASDAQ:GOLD[2]) and Yamana Gold (NYSE:AUY[3]) — have actually performed better than gold itself. The rest have trailed gold.

Guess I’m not crazy.

And just for the record, the sub-par performance for most of the miners doesn’t change if you change the time frame in question to something shorter in duration, or more recent. If anything, it gets uglier.

So much for the love affair with miners.

What About Dividends?

It’s the obvious follow-up question: What about any dividends these gold miners paid that would have pumped up their total return for the time frame in question?

I thought about that, too, and decided to factor in the effects of dividend payments for some of stocks in this group that have been lagging since 2009.

It didn’t help much. Randgold Resources and Yamana Gold still came out on top, though the dividends meant little in terms of total return. And, even though Newmont Gold (NYSE:NEM[4]) paid out more in dividends than any other gold miner, it still didn’t make a meaningful dent in its underperformance.

It’s odd, simply because gold remains priced in the stratosphere, yet gold mining stocks still haven’t offered the big rewards investors might have been expecting … in dividends or capital appreciation.

But Why?

Surprised that so many of the gold miners have lagged behind gold when they should have been roaring? I’m not, for one simple reason — hyped stocks rarely meet those raised expectations, and if there’s one group that has been hyped over the past three years, it’s gold miners.

Of course, it doesn’t help that mining gold is more expensive for some of the miners than they might let on. Indeed, even with gold near all-time highs, some of the top-tier mining names still are struggling to turn a profit; any given miner might not even be producing enough gold at any point in time to cover its overhead.

When you take a step back and look at the bigger picture, a lot of things have to come together to make gold mining “worth it.” Gold has to be priced firmly enough to cover fixed costs, as well as variable costs, and a miner has to actually have a productive gold resource it can rely on to make capital expenditures (equipment and leases) pay off long enough to turn a profit. That’s a lot to ask, especially when a disruption in just one of those pieces of the puzzle can torpedo the whole thing.

For the time being, I’ll just stick with buying the commodity until it becomes very clear that a particular miner has the right cost-containment in place, and has enough proven reserves (i.e. gold in the ground) to merit an investment.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

  1. GLD:
  2. GOLD:
  3. AUY:
  4. NEM:

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