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2012’s Best Gold Play Might Be Miners

Gold should rise, but not as fast as equities


As I’ve noted in a number of my writings, market internals are strongly suggesting a return to reflation this year in what could be an environment for risk assets similar to 2003 and 2009.

To be clear, I am not a perma-bull whatsoever. I simply try to identify what the conditions are suggesting could be a high-probability scenario.

However, I’m not quite convinced though that gold can outperform equities this time around, from the standpoint of being up more/down less than stocks by year-end. I recently wrote about this in an article titled “Betting on Inflation? Don’t Bet on Gold.” There, I noted that equities have been performing better than gold since September 2011, and that the relative trend could continue.

My primary reasoning? If 2012 does end up being the year of reflation, gold likely would participate on the upside. However, compared to equities, the yellow metal is too small a market to absorb big sums of capital which could be reallocated away from Treasuries and into equities, particularly at the institutional level. Bearishness toward equities from a fund-flows perspective also has been very strong, meaning that from a contrarian standpoint, the asset class is ripe to surprise on the upside more so than gold itself.

Perhaps, then, its better to consider the stock side of the gold trade, particularly if equities as an asset class begin to attract more and more capital from fixed income. Take a look below at the price ratio of the Market Vectors Gold Miners ETF (NYSE:GDX) relative to the SPDR Gold Trust Shares ETF (NYSE:GLD). As a reminder, a rising price ratio means the numerator (GDX) is outperforming (up more/down less) the denominator (GLD).

I’ve annotated the trends in leadership in terms of gold’s performance relative to the stock side through gold miners. While trends are choppy, we can see that in 2009 (reflationary environment), gold miners strongly outperformed gold itself. In 2011, gold took the leadership role while equities more broadly declined as the deflationary pulse was felt globally, thanks to Europe. Notice the far right of the chart, where the weakness in miners relative to gold might be reversing.

Because everything goes through cycles, the longer something outperforms, the more likely it is to underperform going forward. The clear leader last year was gold. This time around, gold miners might be the better place to position into if you’re a believer in the gold story.

Certainly one could take advantage of this idea by positioning directly into GDX itself, which is more preferred since it largely minimizes the risk of a specific gold company not performing as one might otherwise hope. You also could make a more aggressive bet in smaller gold miners through the Market Vectors Junior Gold Miners ETF (NYSE:GDXJ).

Regardless of how one decides to position, it is worth considering the possibility that relative to gold, anything equity-oriented (such as GDX and GDXJ) could perform more strongly.

The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing. The commentary does not constitute individualized advice. The opinions herein are not personalized recommendations to buy, sell or hold securities.

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