Holiday Shopping Tips for Gold Stocks

By Brad Zigler

You'd think last month's earnings releases would have given a boost to gold stocks, since four of the five components of the NYSE Arca Gold Miners Index (GDM) reporting posted positive results. Yet, going into the last week of October, miners' stock prices slumped, only to emerge at the end even lower.

Of course, you could have said virtually the same thing about gold itself, but stock losses were tenfold the slippage in bullion. The exchange-traded fund tracking the miners' index—the Market Vectors Gold Miners ETF (NYSE Arca: GDX)—gave up 9.3 percent last week, while the value of the metal-holding SPDR Gold Shares Trust (NYSE Arca: GLD) eased only 0.9 percent.

So why should good news produce such bad results?

Well, to a certain extent, there's truth behind the old adage "buy on the rumor, sell on the fact." There were whispers on the Street—some good, some not—about the miners' numbers.

Agnico-Eagle Mines Ltd. (NYSE: AEM), for example, was expected to put up per-share earnings of 20 cents for its third quarter; before its earnings report, the company's stock traded above $68. Analysts then started talking up a 19-cent figure. When the company posted an 11-cent loss, however, traders marked down Agnico's shares by more than $15.

Disappointment with poor financial results is understandable, but even the miners' good news went unrewarded. Newmont Mining Corp. (NYSE: NEM) blew the doors off analysts' earnings guesses, taking in 79 cents a share after the sell side forecasted earnings of only 57 cents. Newmont's price reaction? Shares slumped nearly $2.00 before settling halfway up the $43 handle.

A similar scene played out when Barrick Gold Corp. (NYSE: ABX) announced a 54-cent-per-share operating profit. The Street had been eyeing a 47-cent profit before hedging charges, and rewarded company shareholders with a 3 percent haircut.

Likewise, Gold Fields Ltd. (NYSE: GFI) and Eldorado Gold Corp. (NYSE: EGO) both turned in results that met or exceeded Street expectations, only to find sellers anxious to work their share prices lower.

But rumors don't tell the whole story.

Gold Stocks: The Hybrid Investment

The important thing to remember about gold stocks is that they represent hybrid investments. Like any equity, a portion of their returns will reflect traders' sentiments about the issuers' financial prospects, as well as its management team, the general equity market conditions and other idiosyncratic factors. The rest can be attributed to the market's disposition toward gold. Therefore, gold miners in essence serve two masters: the gold market and the stock market.

In the aggregate, 54 percent of the returns chalked up by gold stocks is "passive"; that is, directly ascribable to gold. Of course, the influence of gold upon individual issues varies, but that variance is vitally important in shaping investor expectations.

Gold Miners Index Component Three-Year Relative Share Price Performance

When selecting stocks, investors often look at an issue's MPT (modern portfolio theory) statistics, such as beta and alpha. Beta measures the variance in a stock's price history relative to a market benchmark; simply put, beta tells an investor how volatile that stock's price trajectory is likely to be. Alpha, on the other hand, represents the stock's return in excess of the market and of the risk-free yield on Treasury securities; alpha informs the investor how much excess return—positive or negative—has resulted from that stock's volatility differential in the past.

Investors can often find MPT statistics for individual stocks published by market newsletters or on Web-based financial platforms. Investors should know, however, that they're not getting the whole story about gold miners' risk from these figures.

The Problem With MPT

Here's the problem: Universally, the perspective taken by these analytics is from the vantage point of the general equity market. The stats measure a stock's risk compared, typically, to the blue-chip Standard & Poor's 500 Composite. But mining stocks are bound to look quite a bit different when compared with an index containing the likes of Bank of America and Boeing. Just look at the difference in returns over the past three years: Blue chips tracked by the S&P 500 have sunk at an average annual rate of 5.5 percent, while stocks comprising the NYSE Arca Gold Miners Index have risen 3.2 percent.

When you calculate the three-year MPT stats for the GDX exchange-traded fund, you're likely to find its beta as ".73" and its alpha as ".07." The beta figure says the fund's price tends to vary at 73 percent of the rate of the S&P 500. The alpha stat tells you the miners' fund cranks out a risk-adjusted annual gain that's 7 percent above that of the S&P benchmark. All that certainly makes the ETF look pretty attractive.

An investor who believes these figures represent the totality of GDX's risk, however, is bound to become disappointed. For one thing, the portfolio stats are backward-looking. They describe the fund's historic arc, but can't possibly guarantee future results.

More importantly, though, they only describe the risk embedded in gold mining stocks that's attributable to the equity market. Nothing's said about the other half—more than half—of the fund's exposure.

To get that side of the story, MPT stats need to be run against gold's price. For good measure, we'll run the stats for each GDX component that released earnings last month vs. gold, the stock's parent gold miners' index and the broader equity market:

Three-Year Gold Miners' Stock Performance

	Beta vs. S&P 500	Alpha vs. S&P 500	Beta vs. Gold Miners Index	Alpha vs. Gold Miners Index	Beta vs. Gold	Alpha vs. Gold
GDX	0.73	0.07	--	--	1.68	-0.18
EGO	0.59	0.32	1.07	0.27	1.90	0.07
AEM	0.74	0.18	1.08	0.11	1.90	-0.09
ABX	0.55	0.06	0.95	0.01	1.72	-0.17
NEM	0.71	0.18	0.83	-0.08	1.43	-0.23
GFI	0.97	-0.08	1.08	-0.16	1.62	-0.33
Stocks' Average	0.71	0.15	1.00	0.03	1.71	-0.15

While four of the miners look like winners when measured against large-cap issues, only three produce better risk-adjusted returns than the universe of senior gold stocks. Just one, however, actually outperforms gold itself.

The lesson that should be taken away from this is simple: When shopping for investments, statistics can't tell you everything, but the right statistics can certainly tell you more.

Disclosure: Author owns none of the above-mentioned stocks

Comments

[Nextel Acce...:]

I think gold is going down, this would explain the stock movement

Nov 09 02:49 PM

[JeffDB:]

Great article. Thanks for posting it.

Nov 09 03:02 PM

[Alan Young:]

Great analysis, thank you!

I find it astonishing that all these stocks have a beta (vs. S&P) of <1. What's with the stereotype that commodity and mining stocks are volatile?

Nov 09 03:48 PM

[Smarty_Pants:]

There's a simple approach that works. Hold gold stocks and cash in whatever proportion you feel comfortable with.

When the prices on your stocks go up, sell a few shares. When the price goes down, buy a few shares. Over time you will build the number of shares you own and if the stock is in an uptrend your account balance will grow too.

What price change you use is your choice, as is the amount you buy/sell each time. There are many different ways to proceed and none of them are 'wrong'.

Nov 09 11:10 PM

[venividivici:]

Back in April I posted several comments on this site about the gold stock I had invested in, Kingsgate Consolidated, KCN on the ASX and you would be very happy now if you'd followed my advice.

KCN has a lot going for it, a great mine in Thailand which produces gold at $288 an ounce and terrific exploration upside both at the mine itself and elsewhere, nearby. At the mine itself they found almost twice as much gold as they mined in the last year and plans are well advanced to double the capacity of the mine. They just discovered a second highly prospective site 6 to 10 km from the mine and recently paid a very nice dividend. I could not be more happy with the share. Give their website a look. You can look back at my previous posting about KCN and you'll see the share has almost doubled in price since I first recommended it.

Nov 13 02:01 AM

[dragonpaw:]

Dude above; the quote re your logo is " Veni; vidi; Vinci".
Consult "Caeser's Gaelic Wars."
(Unless your name is Vici, apologies)

Nov 21 06:10 PM