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The performance of precious metals mining stocks has baffled bulls in recent years, and will likely continue to do so indefinitely. Gold (GLD) broke the $500/oz barrier in early 2006 for the first time in decades and leading low cost producer Goldcorp (GG) exploded to a then all-time-high just shy of $40/share. Just a year prior shares traded under $15 while gold itself was trending upwards but remained under $450/oz.

Today GG trades at $39/share, just pennies higher than it peaked with $700/oz gold in May 2006. Including dividends the widely agreed upon best gold mining company on the planet has returned just over 10% in almost seven years while bullion has more than doubled. GG traded above $50/share when gold first broke the $1500 barrier in 2011 and has lost more than 20% since, while today the yellow metal trades above $1700/oz.

Owners of shares of highly profitable mining giants Barrick Gold (ABX) and Gold Fields International (GFI) can attest to even more disappointing stock performance.

The situation is most easily explained with the same reasoning I used to predict the recent massive decline in solar stocks in a Seeking Alpha article titled Sustainable Products Mean Unsustainable Profits (here). Much like PV panels benefit energy consumers by eliminating recurring costs, gold mining stocks benefit gold buyers by buoying supply in a fixed supply market and permanently reducing their own mineable assets. While solar companies saturate a fixed energy market, thus eliminating future income opportunities, gold producers rid themselves of their most accessible gold and eventually all of it.

Another key reason, even for gold bulls, to avoid owning miners is that operating costs, from equipment to energy to wages, increase under inflationary conditions that benefit the price of bullion.

The mantra of miners as a "leveraged play on gold prices" simply doesn't hold, increasingly so with a longer term outlook.

I can't think of a more fundamentally sound paired trade than long GLD, short (GDX). For outsized returns investors less sensitive to volatility should consider going long silver (SLV), given a historically low gold to silver ratio and generally higher beta associated with the white metal, and short (NUGT), given time decay of leveraged ETFs in addition to massive moves made by the ticker symbol.

Source: Gold Bulls And Bears Should Short GDX