So much for mean reversion.
Gold stocks have been obliterated in the recent market downturn, even as the price of gold has remained somewhat steady. Since Sept. 17, gold stocks — as gauged by the Market Vectors ETF Trust Market Vectors Gold Miners ETF (NYSE:GDX) — have fallen 14.7%, while gold itself has slipped only 2.5%, based on the performance of SPDR Gold Trust (NYSE:GLD). The two industry heavyweights, Newmont Mining (NYSE:NEM) and Barrick Gold (NYSE:ABX), have led the way in the downdraft, each losing more than 20% over the past two months.
The recent slump in mining stands in sharp contrast to the interval from August through mid-September, when GDX rocketed ahead 25.8% and left GLD (+8.9%) in the dust following the Fed’s QE3 announcement . At the time, many investors took this as a sign that gold stocks were finally beginning to play catch-up, but the October-November downturn has dashed those hopes for now. Notably, GDX is now in the red on a three-year basis with a cumulative return of -6.5% — this in a period in which GLD has rewarded investors with a gain of 51.4%.
The fact that gold stocks have lagged by such a margin during a period of exceptional strength for the metal underscores four key shortcomings of miners relative to gold itself:
- You have to be right twice: Gold stocks typically need two factors to be working in their favor simultaneously: Both the price of gold and the stock market need to be going up. From 1984 through the end of 2011, the PHLX Gold/Silver Index (^XAU) averaged a gain of 10.5% in the calendar quarters in which both gained ground, but it lost an average of 2.5% during the quarters in which one or both fell. However, gold and stock prices rose in tandem in only 35% of the calendar quarters in the period, resulting in a performance shortfall for the index. See the full results of the study here. The bottom line: It’s difficult enough to pick the direction of one asset class, but having to be right twice creates a much higher hurdle to success.
- Not a true inflation hedge: Physical gold is seen as being a hedge against inflation, although — as outlined by Pragmatic Capitalism in this article from 2011 — even that is subject to debate. Gold stocks are an even more dubious inflation hedge since their two primary input costs are labor and energy, meaning that they are victims of inflation as much as they are beneficiaries.
- Headline risk: It’s not exactly news that gold stocks have much greater headline risk than the metal. Still, the impact of the recent strikes in South Africa on companies such as Gold Fields Ltd. (NYSE:GFI) and AngloGold Ashanti Ltd. (NYSE:AU), along with the wall failure at Agnico-Eagle’s (NYSE:AEM) Quebec mine last year, help illustrate the added layer of risk that comes with mining stocks.
- Ore quality: This is a longer-term consideration, but an important one nonetheless. With each year that passes, the gold in the ground becomes progressively more costly to dig out as the more favorable deposits are exhausted. This reality mutes the positive impact of a rising gold price by compressing profit margins — and it makes the stocks more likely to lag once the price of gold starts heading south.
Having said this, gold stocks certainly have value for short-term traders. Buying miner shares when they’re oversold is a great way for experienced traders to pick up 5%-10% in just a few sessions. In fact, the sector is probably on the cusp of just such a rally right now. But for those looking for a longer-term way to capitalize on the depreciation of the major global currencies, there’s no contest: Gold is a clear winner over the mining stocks.