Under normal circumstances, one would expect gold mining stocks to generally follow the price of gold. While the performance of individual names may vary due to management practices, in aggregate these unsystematic issues should balance out. Consequently, diversified gold miner ETFs, like Market Vectors Gold Miners ETF (GDX) should theoretically experience reasonably high correlation to the underlying asset that these companies sell.
Well, put reason aside for now. Since the inception of GDX in 2006, gold bullion has dramatically outperformed (see chart below).
(Click to enlarge)
Truth is that gold mining stocks are highly volatile and provide investors with a different kind of beta than pure bullion. Mining stocks are not only exposed to the price of gold, but also to credit risks. Moreover, gold companies are subject to the whims of management, which can destroy shareholder value through hedging practices, share dilutions and production problems. While diversification across several miners may mitigate unique business risks, sometimes business practices can become common place among competitors. Over time, however, one would expect these issues to average out providing investors an expected performance range relative to the price of gold.
The chart below shows the GDX to gold bullion ratio since 2006. This ratio has fallen dramatically over the past several years and has remained below average since the credit crisis of 2008. It is apparent that gold miners have not kept pace with the price of gold - especially post financial crash.
(Click to enlarge)
While currently systemic risks may be dragging down the miners, if one expected the GDX to gold ratio to simply revert to its long-term average, GDX would have to rise by approximately 36% (from Sept 8th intraday prices).
Often, however, when assets overshoot on the downside they overshoot on the upside. So it is entirely possible that gold miners are due for a meaningful rally that brings the GDX to gold ratio back above its long-term mean.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. This is not advice. While Plan B Economics makes every effort to provide high quality information, the information is not guaranteed to be accurate and should not be relied on. Investing involves risk and you could lose all your money. Consult a professional advisor before making any investing decisions.
