Gold Miner ETFs Besting Gold

September 20, 2012

Since mid-July, gold miner ETFs have been beating physically held funds like GLD handily. So what’s going on?


For much of the past four years, gold miner ETFs have risen less than physical funds. In some ways that’s not surprising, since returns of equity funds like the Market Vectors Gold Miners ETF (NYSEArca: GDX) correlate much less to the price of gold than the likes of GLD, which hold actual gold.

Since September 2008, SPDR Gold Shares (NYSEArca: GLD), the $74 billion bullion ETF, has returned 107.4 percent, or about three times as much as the SPDR S&P 500 ETF (NYSEArca: SPY).


Source: Bloomberg

Fund flows data tell the same tale; namely, that investors have flocked much more aggressively to physical funds than equity gold funds, despite the higher “collectibles” tax rate imposed on funds that hold physical gold.

To-date, six gold miner ETFs trade in the U.S. market and have accumulated close to $13 billion in total assets. This number is dwarfed by the $87 million in assets held by physical funds.

Gold has long been considered a safety net, and has done a good job of protecting investors from volatile markets, as the returns above suggest. So, the investment flows since the start of the global financial crisis should come as no surprise.

But as I said, something has changed in recent months, with returns on gold miner ETFs well over twice those on physical funds like GLD.

Part of it is certainly the fact that stocks have been moving upward this year, and gold miner ETFs are equity securities.

A bull market in stocks will make all such securities relatively better off than a bear market. The opposite could be said of physically held gold ETFs: Their prices are based on demand for gold, which increases when the outlook on other investments looks grim.

The most impressive gains during this time period were notched by Van Eck’s GDX and its sister product, the Market Vectors Junior Gold Miners ETF (NYSEArca: GDXJ), as well as the PowerShares Global Gold and Precious Metals Portfolio (NasdaqGM: PSAU).

All have jumped by more than 30 percent in the past two months, compared with GLD’s gain of 12 percent over the same period, as the following chart shows.



Gold Miners vs. Physically Held

Source: Bloomberg

An article in Barron’s this week pointed to technical factors at play. First, the price of gold versus gold equity has been artificially high over the past few quarters and is now leveling back to a more “normal” ratio.

Another reason is that the gold mining industry has been quite inefficient, putting downward pressure on profit margins. The past few years have been marked with heavy expenditures, with relatively little new profit streams to show for it. For example, deep-level mining in South Africa has been plagued by safety issues, depleting ore quality, poor infrastructure and skill shortages.

These inefficiencies and a series of acquisitions characterized by low valuations made investors squirmy.

However, according to the Wall Street Journal, there’s a lot of evidence suggesting mergers with little or no premiums may be the ticket to increasing profits in the gold mining industry.

Typically, these types of mergers have no designated “new owner,” and are instead consummated for mutual benefit. The success in such ventures usually comes sometime after the deal closes, as weaker companies combine to become one stronger entity with lower costs.

It’s easy to see how economies of scale can only be a benefit to a resource-intensive industry such as mining. Then again, culture clashes and management infighting aren’t unheard of.

One final factor is worth mentioning. As I wrote in a previous blog, gold miner ETFs often hold companies that mine metals and minerals other than gold.

Since gold is arguably the least cyclical metal—investing in companies that extract metals besides gold helps fuel price increases when consumer demand rises for products that use, say, rare metals in manufacturing. China’s fascination with the iPhone and other electronics is an example of this.

A lot of cross-currents are at play here, but gold miners are finally outperforming gold like so many have said they would, and I for one am excited to see if their Cinderella moment will last.

At the time this article was written, the author held no positions in the securities mentioned. Contact Ana Kostioukova @ [email protected].

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