Seeking Alpha

Strategies To Benefit From The Upcoming Gold Bull Market

by: Adrián Hernández
Adrián Hernández
Long only, micro-cap, growth at reasonable price, special situations

The physical gold could reduce the portfolio volatility and even outperform equities and bonds returns during adverse financial events, like crises or stock market crashes.

The gold miners are a terrible long-term investment, but they offer wide upside during gold bull markets.

I'll explain why I prefer the precious metals royalty and streaming companies as a long-term investment.

This is the second of a series of articles about my vision of the gold sector. In the previous one, I've discussed why I believe that the gold is undervalued, why it can work well as a hedge for your portfolio and the main catalysts that could drive the gold price higher. You can check it out here: "It's The Perfect Moment To Have Gold As A Hedge For Your Portfolio."

In this article I will focus on the main gold investment options:

  • Physical Gold
  • Gold Miners
  • Precious Metals Royalty/Streaming

In my opinion, the precious metals royalty and streaming companies might offer the best return over the long-term, based on their historical returns compared to the physical gold. The gold miners could work well a short-term speculative investment, and the physical gold could outperform equities and bonds during turbulent times like financial crises, stock market crashes, overall distrust in the economy, etcetera.

There isn't a universal strategy for every investor, but I hope that this article may help you to find the one that fits better to your risk profile and/or asset allocation preferences.

Gold as a hedge for your portfolio

There are some regression studies comparing the annualized returns for a portfolio composed of equity and bonds, then they rebalance the portfolio adding a specific percentage of gold exposure like 10% or 20% of gold mining stocks or physical gold, for instance:

1. The effect of adding a 20% of gold exposure to the 60/40 portfolio after a 42 year period.

Source: BMG

As you can see, the best returns for this 42-year period were achieved after adding a 20% of physical gold exposure, rebalancing the 60/40 portfolio to an asset allocation of 50% stocks + 30% bonds + 20% gold bullion. Furthermore, the portfolio also reduced its volatility (measured as standard deviation). Both factors reflected a higher Sharpe and Sortino ratios (the higher, the better risk-adjusted returns).

2. The effect of adding a 10% of gold exposure to the 60/40 portfolio after a 47-year period:

Source: InvestETF; Seeking Alpha

For this 47 year period regression, a 10% gold exposure slightly increased the annualized return a 0.16% (from 9.16% in the 60/40 portfolio to 9.32%) and it significantly reduced the portfolio volatility a 1.28% (from 10.8% to 9.52%). Both factors increased the Sharpe Ratio by 6 basis points (0.39 to 0.45).

3. The effect of adding a 10% of gold exposure to the 60/40 portfolio during a 30-year period:

Source: Bloomberg; Fabio Herrero

In this case, the hedged portfolio clearly bounced after the 2008 financial crisis, improving the annualized return by 0.55%. The counterargument is that the hedged portfolio doesn't improved the annualized returns until then, but neither did it significantly damage the returns. In other words, the gold worked as an insurance policy.

When the price of gold moves, gold's price isn't moving; rather it is the value of the currencies in which it's priced that is changing.

- John Tamny, Economist, H.C. Wainwright Economics

Physical Gold Vs. Miners

The gold mining is a hard business. It's cyclical, capital intensive, requires operational and financial leverage and a lot of things could go wrong. According to the data from BMG, the gold miners rarely beat the physical gold returns in an annualized basis. The following graph represents a regression study from 1973 to 2015:

Source: Nick Barisheff (BMG)

Even during different periods of market stress and/or financial crises, the physical gold keep beating the gold miners:

Source: Nick Barisheff (BMG)

In my opinion, during periods of financial stress, the gold miners get affected by the massive sell-off in the equities markets, then, some of the scared investors move their money from the equities to a safe haven like the physical gold.

When global economic conditions deteriorate, investors inevitably seek a safe haven for their wealth, rather than more speculative investments.

- Nick Barisheff (BMG)

Using a different period, if we compare the total returns of the Gold Miners ETF (GDX) since its inception in May 2006 with the largest physical gold ETF (GLD), we have a clear winner:

ChartGLD data by YCharts

In summary, investing in gold mining for the long-term is really a bad idea unless you have the required skills and knowledge to perform a successful stock picking of the successful gold miners, and even so, you'll also need a bit of luck.

Gold Mining Vs. Royalty and Streaming Companies

According to the data from Desjardins:

At gold prices of <US$1,400/oz, the royalty group offers superior free cash flow to the producer group.

The royalty group includes: Franco-Nevada (FNV), Wheaton Precious Metals (WPM), Royal Gold (RGLD) and Osisko Gold Royalties (OR).

According to the graph, the gold miners would need a sustained gold price above $1.400/oz just to break even with the FCF of the royalty group. In the long term, after the last 10 years, any of the Big 3 gold royalty companies outperformed the Gold Miners index (NYSEARCA:GDX) or any of the Big 3 mining companies (Newmont, Barrick and Goldcorp):

If we look at the total returns of the royalty group from August 2008 -including dividends- we have a clear winner: Franco-Nevada, returning a 703%, outperforming the S&P 500 ETF (163%) and Gold Miners ETFs (61%):

ChartSPY Total Return Price data by YCharts

But, to be fair, if we look at the returns from December 2008, Wheaton Precious Metals also performed very well, with a 453% total return.

ChartSPY Total Return Price data by YCharts

In my opinion, the gold royalty and streaming companies could represent a good long-term investment and I'll talk in-depth about them in another article.

Gold Mining Companies: Quick Valuation

The HUI to Gold ratio is often used as a quick valuation method for the gold mining sector. The HUI is the ticker for the NYSE Arca Gold BUGS Index and it tracks 18 gold mining companies. According to the HUI component list, the three main holdings -Newmont Mining (NEM), Barrick Gold (ABX) and Goldcorp (GG)- represent the 41.6% of the total, so, any big move in any of these companies will significantly impact in the index.

A high HUI to Gold ratio is usually correlated with gold bull markets, where the gold mining companies achieve their highest margins thanks to their operating leverage, like the 2000-2006 period when the ratio peaked around 0.60, or between 2008 and 2010 with highs of 0.41.

In the other hand, the ratio plummets during the gold bear markets, correlated with the lower margins, profits and cash flows for the gold mining components of the HUI index. The ratio hit lows of 0.14 in the year 2000 and 0.10 during the 2015. During the last weeks it has been trading around 0.11 and 0.12, not far from the lows of 2015.

This is the historical evolution of the HUI to Gold ratio since 1999:

Source: StockCharts

Speculative Short-Term Plays

I will show three examples of the returns from the different investment options:

1. Mini-Bull Gold Market 2015-2016 (~7 months):

Source: Author

During this seven-month period, with a perfect and ideal timing, we could have tripled our money if we had successfully chosen Barrick Gold as our speculative buy.

I would limit my speculative buy to a Gold Miners ETF to diversify the risk. Choosing a sole gold miner would expose you to unexpected events (production decline, mine temporary shutdown, etc.). In average, the 3 ETF investment options (BUGS, GDX and GDXJ) returned a 140%, more than doubling the initial investment. Don't be too greedy!

But, if we didn't sell the shares during the July highs, we would have entered into a Mini-Bear gold market, reducing the return.

2. Mini-Bear Gold Market July-December 2016 (~5 months):

Source: Author

So, you could also have a good return if you had invested during the December 2015 lows until the December 2016 lows, with a 48% return in average for the 3 mentioned ETFs.

But, you could also find yourself in a harder scenario, with a -29% decline in gold prices like you will be risking to lose half of your initial investment:

3. Mini-Bear Gold Market January-June 2013 (~6 months)

So, with the worst timing, buying in the January 2013 highs, you could also have lost half of your initial gold investment in just 6 months.

Please note that these are mere examples and during the mentioned periods, the investments could suffer a great volatility, which is not measured.


The physical gold could reduce the volatility and improve the overall portfolio return even in the long-term, especially during financial events like crises, stock market crashes...

The Gold Miners are not suitable as a long-term investment but they offer the greater upside during gold bull markets, so, in my opinion they could be used as speculative short-term plays, but don't forget the downside risk. My favorite option is always invest for the long term, that's why I prefer the precious metals royalty and streaming companies. Their maintenance capex is typically almost zero, and these companies could just sit and do nothing and they will keep generating positive cash flow for years.

In my next article I'll talk about the different options to invest in physical gold, making emphasis on the difference between the ETFs differentiation. If you want to keep updated, please click on the "Follow" button located just below the article's title, and if you found this article interesting, please click on the "Like" button below to get the article to more readers.

Don't forget to draw your own conclusions.

Disclaimer: This article does not represent any kind of investment recommendation or advice.

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.