The old wisdom that it is the cost structure of the mine that drives profits and that enable us to rank mine returns is ignored at the moment.
A simple two- factor model (price of gold and market) doesn't add to this old wisdom in giving us a percentage estimate of the expected return contingent on a given change in the price of gold.
In 2014, as you can see from the table 1, S&P 500 (Mkt) and gold (the metal) don't provide any explanatory power to NYSE:ABX and NYSE:AEM returns, in conjunction with a tumble in the price of the precious metal. Both variables (return on the S&P500, the stock market, and the return on gold are not statistically significant to explain the returns on ABX and AEM).
It is also interesting to check 'predicted' returns on NYSE:ABX and NYSE:AEM against actual returns on NYSE:ABX and NYSE:AEM, using a two-factor model to estimate the beta coefficients over a period of 5 years (2010-2014).
Over the period observed (2010 - 2014), the market (S&P 500) has an explanatory power to ABX and AEM returns; instead gold has an explanatory power to ABX returns only.
The table no. 3 shows average weekly and annual returns on the gold and the market (S&P 500) of year 2015.
The return on gold was -9.077%, as the price dropped from $1,266.063 per troy Ounce to about $1,151.142.
The S&P 500 return was 0.224% (NYSE:AVG) over the same period (2015).
Given these returns on gold and the S&P500 over 2015 and the estimates of Beta1(S&P 500) and Beta2 (NASDAQ:GOLD) for both gold stocks as of the beginning of 2015, I want to see how close the returns on NYSE:ABX and NYSE:AEM 'predicted' by the model were to those that actually occurred.
The predicted return on NYSE:ABX in 2015 was -3.26%; the actual return was -26.52%. The return on NYSE:AEM in 2015 was 0.08%; the actual return was 6.76%. There is no question that the difference between 'predicted' and actual returns is due to a low multiple Rsq (but this does not undermine the reliability of the model, considering F significance and residual plots), but it is also due to the fact that a simple two- factor model (price of gold and market) doesn't add to this old wisdom.
Let's take a look at a bunch of gold stocks.
Higher beta gold coefficients should normally correspond with gold stocks that have higher cost/revenue ratios and vice-versa. This is "consistent with the old-fashion notion that mine's cost structure and average grade are the key determinants of the market's response to a given change in the price of gold - whatever might be the information, events, or psychology associated with the fluctuation in gold price, changes in wages and energy costs, and other factors" (McDonald, John G., and Bruno H. Solnick. "Valuation and Strategy for Gold Stocks*." The Journal of Portfolio Management 3.3 (1977): 29-33.).
As you can see from the table no. 5, Barrick Gold Corporation is the only gold mining company that is associated with a statistically significant beta gold coefficient. For the rest there isn't any relation between the beta gold coefficients and the key determinants.
This means that changes in wages, energy costs and other factors (for example: gold is sold at dollar price and wages are paid in another currency) have an explanatory power to gold stocks returns.
As I have explained in my previous article 'Instead of changes in the prices of gold (the metal), I would keep an eye on NYMEX (Crude Oil) and DXY (US Dollar Index) movements to assess this stock for the coming months. NYMEX and DXY are the only 2 factors (out of a total of 6) which provide significant explanatory power for NYSE:GG.'
With this article 'I found out that only NYMEX (Crude Oil price) and DXY (US dollar Index) factors provide significant explanatory power for all of the gold stocks over the period observed (January 17, 2006 - December 29, 2014, weekly observations): and that there is a negative relation between the latter and gold stocks' returns.
Gold stocks are less volatile than crude oil (NYMEX), but both move towards the same direction...'
After having considered several ratios and comments to my previous articles, NEM and AEM seem to be better positioned than their peers.' and the preferred ones.
According to the old wisdom the cost structure of the mine drives profits and that enable us to rank mine returns.
Should the old wisdom be ignored for the moment?
Instead of changes in the prices of gold (the metal, bullion market), I would keep an eye on NYMEX (Crude Oil) and DXY (US Dollar Index) movements to assess this stock for the coming months.
Newmont Mining Corporation and Agnico Eagle Mines Ltd seem to be the gold stocks that are better positioned than their peers.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.