Why the Time Could Be Right for Gold Mining Stocks

Conditions have improved for gold equities, and economic policy decisions being made in Washington could further increase the investment appeal of these mining stocks.

The charts below clearly illustrate the relationship between gold-mining stocks and the federal budget.

The top chart below compares the total-return performance of the S&P 500 (blue line) with that of the Toronto Gold & Precious Minerals Index* (gold line) going back to 1971, when President Nixon ended dollar convertibility into gold and deregulated the price of gold.

At that time, the United States was in the thick of the Vietnam War and was pumping billions of dollars into the financial system to pay for it. The dollar’s value dropped compared to other currencies, and the demand for gold and its price shot up. At the same time, the U.S. stock market was languishing.

The bottom chart shows the federal budget, and the trend is readily noticeable—when the federal government is spending more than it takes in, gold stocks tend to outperform the broader market.

As indicated in the top chart, $100 invested in the S&P 500 at the start of 1971 underperformed the gold-stock index essentially for a quarter-century. In each of these years, the federal government engaged in deficit spending. The S&P 500 surpassed the gold-stocks in 1997, in the midst of the tech boom and budget surpluses under President Clinton.

When those surpluses reverted to widening deficits after the September 11 attacks, you can see the spread between the broad market and gold equities narrowing. At the same time, another important event occurred—China began to deregulate its precious metals markets. During that period, the S&P 500 dropped before largely leveling off, while gold stocks charged forward.

Gold stocks have delivered a 9.9 percent average annual return since 1971, while the S&P 500’s annualized return has been 9.6 percent. That $100 invested in gold stocks in 1971 would have grown to nearly $3,800 at the end of May, while the same amount in the S&P 500 Index would be worth about $3,400.

So now that we’ve established the relationship between gold stocks and the federal budget, let’s look at the current situation.

The federal government, which has spent huge amounts to save the banks and stimulate the domestic economy, is expected to see a $1.8 trillion gap between revenue and expenditure. You can see from the long blue line at the far right of the bottom chart that this is a deficit on a scale beyond what we’ve seen in the past.

If the federal budget projections are accurate, we can expect massive deficits to continue, which will likely fan inflation fears and keep downward pressure on the dollar. These large deficits, combined with China’s growing appetite for gold, create the potential for gold stocks to remain an attractive investment relative to the broader market for some time to come.

* Time series for Toronto Gold & Precious Minerals Index is a composite of this index’s returns from 1970 to 2000. Thereafter, the S&P/TSX Gold Index is used. Both series are analyzed based on their returns achieved in US dollar terms.

This article originally appeared in the U.S. Global Investors Weekly Investor Alert.

The S&P/TSX Global Gold Index is an international benchmark tracking the world's leading gold companies with the intent to provide an investable representative index of publicly-traded international gold companies.The Toronto Stock Exchange Gold and Precious Minerals Total Return Index is the total return version of the Toronto Stock Exchange Gold and Precious Minerals Index with dividends reinvested. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.

Comments

[ScroogeMcduck:]

Wow very interesting graphs frank, it looks as though the gold rally hasnt even started yet

Jun 09 11:12 AM

[Louis Paquette:]

Frank, we missed you at the Conference in Vancouver on Sunday and Monday. Everyone was so pessimistic. We could have used more of your positive outlook.

Jun 09 12:21 PM

[DONE_SONZ:]

They can rise substantionally higher.Eps Xs a rising gold price.Simple.

Jun 09 01:23 PM

[Robert Nabloid:]

People were pessimistic at the gold conference? They're pessimistic about the future of gold? Or??? Please explain!

Lately I've heard rumours that the Chinese are about ready to stop using so many US dollars.
- There is a meeting between Russia, China, India and Brazil about NOT using US dollars coming up soon.
-I heard a rumour that the Suadi Arabian King wants to be paid with gold for his oil...
- The US is continuing to print and spend beyond imagination.

What is there to be pessimistic about in terms of the future of gold? It is so bright it is blinding...


On Jun 09 12:21 PM Louis Paquette wrote:

> Frank, we missed you at the Conference in Vancouver on Sunday and
> Monday. Everyone was so pessimistic. We could have used more of your
> positive outlook.

Jun 09 06:02 PM

[Mad Hedge F...:]

this area is going to be hot. Brace yourself for the impending gold shortage. Gold shortage? Yup. Last year, South Africa suffered its steepest decline in gold production since 1901, falling 14%, to a mere 232 tons. It now ranks only third in global production of the yellow metal, after China and the US. Severe electricity rationing, a shortage of skilled workers, and more stringent mine safety regulations have been blamed. Choked off credit has frozen the development of new capital intensive deep mines, as it has for everybody else. Rising production costs have driven the global breakeven cost of new gold production up to $500 an ounce. In the meantime, the financial crisis has driven flight to safety demand for gold bars and coins to all time highs. Last year, the US Treasury ran out of one ounce $50 American Gold Eagle coins, now worth about $980. Competitive devaluations by almost every central bank, except Japan, mean that currencies are not performing as the hedge that many had hoped. It all has the makings of a serious gold shortage for the future. Could last year’s downturn be a blip in the eight year bull market? When we break $1,000, which could happen any day now, watch out above!

Jun 09 07:04 PM