Gold: Metal or Stocks

By Brad Zigler

Real-time Monetary Inflation (per annum): 8.5%

Just before the U.S. Independence Day holiday, we published a Desktop item examining silver's weakening ("Silver's Strength Waning") relative to gold.

Readers should keep in mind a couple of things about last week's article. Though the article headlined silver, it was really a commentary on gold's purchasing power. An ounce of gold has the equivalent value now of some 70 ounces of silver. A month ago, gold was worth only 61 ounces of silver. So, over the last month, gold strengthened and silver weakened. In relation to one another, that is. That's important to remember.

Both gold and silver are grinding through a seasonal (see "The Season For Gold? Not Yet" and "The Not-So-Golden Days Of Summer") slump presently. Neither looks especially buoyant.

Which brings us to the second point worth remembering: Silver's fortunes change constantly. The gold/silver ratio is 70-to-1 now; it's likely to vacillate significantly before year's end. After all, gold's multiple started the year at 80x, dipped into the 60s and is now rebounding to the 70s.

When we say that gold's strengthening, that's not to say that gold or its proxies are due to take off on a gallop to the upside. If you're a silver aficionado, you might view this as an opportune time to dollar-cost-average into more metal, but a rising gold/silver ratio shouldn't be taken as a signal to start buying gold hand over fist.

COMEX Gold (Aug. '09)

That, of course, won't dissuade inveterate aurophiles from making purchases now. For these folks, the question worth asking is whether bullion (or bullion proxies) are a better buy than gold mining stocks.

This year, gold mining stocks, represented by the Market Vectors Gold Miners ETF (NYSE Arca: GDX) has outgunned the bullion-backed SPDR Gold Shares Trust (NYSE Arca: GLD) by better than a 2-to-1 margin. GDX is up 13.1%; GLD's gained just 5.5%. The miners' advantage has been reflected in a stair-step decline in securities' price ratio.

Gold Bullion (GLD) vs. Gold Mining Shares (GDX)

There's a price for the excess return earned by the miners: volatility. The mining ETF's standard deviation is more than that of the bullion trust's. Expressed in portfolio terms, GDX can be said to have a beta of 1.64 against gold.

That's an important thing to keep in mind because mining stocks straddle the fence that separates the commodity and equity realms. Miners behave more like the metal in bull trends, but more like the general stock market when gold's downtrending.

Thus, a bet on gold miners now necessarily includes a side wager on the stock market.

Comments

[Macro_Man:]

I think the next 3 to 4 weeks is not a good time to be long risk. I think asset values and stocks take off again for a final leg up sometime around early August. Perhaps brought on by favorable jobs data. Until then slightly short or flat is the way to go.

Jul 07 07:07 AM

[TXFLYGUY:]

It will be a long time before the DJIA bounces back. Meanwhile, with pressure on the dollar (China/India), plus the inflation that will occur in 18 to 24 months, gold and related issues are a strong buy now. With the U.S. economy running downhill faster than a runaway freight train and no end in sight (just ask the Vice President who admitted they got it wrong), gold is poised for a major rally.
As far as jobs data, it will continue to erode well into next year.

Jul 07 10:24 AM

[texpat:]

The metal is for insurance, for wealth preservation. It's a boring asset in the long run, but there are times when it does very well, and such a time is on the horizon.

The shares give leverage to the gold price, especially those of high cost producers, where a $100 increase in the gold price can turn losses into earnings. It's a good observation that the mining stocks also follow the general market when gold is doing nothing much.

Jul 07 11:00 AM

[DmytrenkoArtem:]

i think the way is to understand demand on gdx and gld.. but not comparing rations.. when we comparing ratios we saw only numbers, but we need to see the nature of fundamentals...

Jul 07 03:41 PM

[Living4Divi...:]

I am not a Gold bug and do not advocate holding Gold. Physical gold ownership is Gold is for times of societal breakdown or hyperinflation - - if society breaks down, you might not be able to cash in your certificates for the physical metal. If you are going to own Gold - I would think the best thing would be physical. Coins do not have to be assayed - they are easily sold. Therefore coins are better than ETFs like GLD IAU.

Since I do not advocate holding Gold, for the people that absolutely, positively must have it in their portfolio, I think stocks of Gold Mining companies are the best bet. At least with this route you get a company that earns profits and hopefully pays dividends. Furthermore, you get to control a lot of Gold already in the ground - that can be mined if Gold shoots up to some astronomical figure. Sort of like a warrant on Gold.

Since society is not breaking down, I would say this is the best way to go currently.

Jul 10 11:42 AM