By David Berman
Investors let Barrick Gold Corp. (NYSE:ABX) know what they thought of the gold producer’s decision this week to expand into copper production through its takeover offer for Equinox Minerals Ltd. (OTC:EQNMF): Their collective boos sent the shares down more than 9 per cent, even as gold prices hit successive record highs.
But the fact that Barrick’s share price has lagged gold is neither new nor confined to Barrick. Indeed, large-capitalization gold producers have been struggling next to gold for some time, at least in relative terms.
The numbers are compelling when you compare gold with the performance of the NYSE Arca Gold Bugs index, a 16-member index that consists of international biggies such as Barrick, Goldcorp Inc. (NYSE:GG), Newmont Mining Corp. (NYSE:NEM) and AngloGold Ashanti Ltd. (NYSE:AU). Over the past five years, the index has risen a total of 60 per cent, after factoring in dividends. But gold’s return is more than double that, at 135 per cent.
Gold has triumphed over these large-cap producers over the past three years and 12 months, too. And for all the hoopla surrounding gold’s rise above $1,500 (U.S.) an ounce in 2011, gold stocks have done little more than tread water this year.
For equity investors, this is a disappointing trend. Producers are supposed to be a leveraged bet on the commodities they produce. That’s because many of their costs are fixed, so rising commodity prices translate into pure gravy.
Before the financial crisis, gold producers were the only way to score significant gains with a gold investment. Between 2001 and 2006, the Gold Bugs index outperformed gold-the-commodity by a factor of four.
What has changed? Large-cap gold producers have been getting themselves into trouble with hedging strategies, currency fluctuations, labor and environmental conflicts and management mess-ups. Given their size, they are also unlikely takeover candidates.
Perhaps more important, though, physical gold has been hogging the limelight. For investors who believe that the U.S. dollar will continue to sink, inflation will soar and the global economy will go down the tubes, gold producers are an unnecessary middleman to gold itself. The rise of gold exchange-traded funds has given these investors an easy way to make this bet.
But if you’ve missed out on gold’s extraordinary runup, large-cap gold producers are likely the best way to play gold right now. They are out of favor, which gives them a safety cushion should gold prices retreat. And if gold continues to rise, these producers will have a lot of catching up to do as their profits explode.