Investing In Gold: Miners Or Metal?

| About: SPDR Gold (GLD)

Investors seeking to invest in gold have multiple options from purchasing stock in mining companies to physical gold bullion to a variety of financial instruments, including the SPDR Gold Trust ETF (NYSEARCA:GLD). While there are disadvantages and advantages to these vehicles, there is a critical question as to how much exposure each has to the underlying commodity. Clearly, physical gold bullion will track the price of gold perfectly; however, it has higher transaction costs, including storage and security.

One way of quantifying the exposure to gold of the various instruments is by regressing against the benchmark GLD. This provides a relative level of exposure, as well as a correlation coefficient. Higher correlations imply a security that more closely tracks gold. For example, the broader market, as measured by the S&P 500 Index Trust ETF (NYSEARCA:SPY), has a very low correlation to GLD. In fact, over the last three-four years, the correlation is around 20%, which is quite low. This also makes gold a very popular asset category since it provides some diversification benefits. However, it would be even better if GLD had a negative correlation.

A surprising correlation to gold

The following table shows some leading mining companies:

Gold Miners and ETFs
Ticker Name Market Capitalization or Assets ($ billions)
ABX Barrick Gold Corporation 42.4
NEM Newmont Mining Corporation (Holding Company) 28.4
AU AngloGold Ashanti Ltd. 13.7
KGC Kinross Gold Corporation 11.7
GG Goldcorp Incorporated 37.5
GDX Market Vectors Gold Miners ETF 8.5
GDXJ Market Vectors Junior Gold Miners ETF 2.6
GLD SPDR Gold Trust 71.3

Source: Yahoo Finance, Google Finance

One interesting note is the rise in assets over the past 18 months of the Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ), Market Vectors Gold Miners ETF (NYSEARCA:GDX), and GLD, which has increased around 40%. This is despite recent declines in the other leading gold miners listed. The following table shows the correlations to GLD over 24, 36, and 48 month periods.

Ticker 24-Month Correlation 36-Month Correlation 48-Month Correlation
GLD 100% 100% 100%
SPY 32% 20% 21%
GDX 87% 85% 85%
AU 67% 71% 69%
NEM 64% 68% 78%
ABX 71% 73% 78%
KGC 68% 64% 70%
GG 78% 76% 78%

Source: Based on monthly split and dividend adjusted prices from Yahoo!Finance and author calculations.

At first glance, these correlations look pretty high, except for the obvious SPY to GLD. However, 70% and 80% are decent, they are not extremely high. Small-cap U.S. stock ETFs often correlate to SPY at 95-plus% levels. Furthermore, several emerging market ETFs, often thought to provide good diversification benefits, correlate in the 80s%. So while mining stocks are correlated, it is not lock step. An investor should not count on a mining stock rising in price, simply because the price of gold is increasing. The following section explores these issues and identifies some of the root causes.

Key Issues

This analysis does have some limitations and requires further detailed analysis of the companies to eliminate other possible explanations of valuation, margin and performance. Key factors include hedging decisions, overall exposure to gold, and management strategy.

1. Hedging - Because gold is a commodity with a futures market, it is possible that certain companies have hedged a portion of their production and not captured the full appreciation of the gold prices over the past couple years. Furthermore, these companies may have hedges going forward that will limit their earnings if gold prices continue to increase. Some companies, have recently announced the elimination of their hedges. Barrick Gold Corporation (NYSE:ABX) announced the discontinuation of its hedges back in 2009.

2. Exposure to Gold - While the companies reviewed are primarily in the business of exploration and production of gold, they are engaged in other activities for other metals, often including silver and copper as well as lead, zinc, and other metals. The correlation quantification helps get at this issue.

3. Management strategy - Correlations and performance will change, based on stated management goals and decisions. Determinations to make significant investments or distribute cash flow to shareholders can impact future performance.

GLD returns have outpaced these miners recently

However, at the end of the day, investors are looking for returns. The following table shows the recent performances of these different securities.

Ticker 12-Month Return 24-Month Return 30-Month Return
GLD 9% 34% 58%
SPY 32% 34% 32%
GDX -2% -3% 22%
GDXJ -8% -16% 9%
AU -12% -21% -3%
NEM -7% -5% 17%
ABX -8% -6% 14%
KGC -30% -45% -39%
GG 3% 8% 27%

Source: Based on monthly split and dividend adjusted prices from Yahoo!Finance and author calculations.

So none of the gold related securities has outperformed GLD. GDX has outperformed GDXJ over each period selected. Interestingly enough, GDX has outperformed almost all the other gold stocks over these time periods - which suggests that I should broaden my sample of gold miners.

Conclusion: The individual miner approach has more risk

Based on the varying performances, if an investor wants to bet on gold, it is best to choose a financial equivalent, rather than a mining stock. While mining stocks also track gold, they are exposed to several other macro variables, as well as the idiosyncrasies of individual companies. Investing in mining stocks requires a detailed assessment of each company and not just a belief that gold will go up. This article clearly demonstrates that with both Kinross Gold Corporation (NYSE:KGC) and AU.

Disclosure: I am long SPY. 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.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.

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