The Commodity Investor: Gold Stocks Get Caught Up In Global Equity Sell-off

January 23, 2012

Rising production costs and volatility in global equity markets have trumped fundamentals for gold miners of all sizes.



Editor’s note: This is the first of two columns that will examine why have gold stocks have underperformed gold bullion and which gold equities are expected to outperform in 2012. The second column will appear on Feb. 6.


When you plot gold prices in 2011 versus the Market Vectors Gold Miners ETF (NYSE: GDX), which tracks the performance of 31 mature gold companies, you quickly see that the GDX underperformed bullion by a whopping 26 percent. While bullion prices for the year—as measured by the SPDR Gold Shares ETF (NYSE Arca: GLD)—were up 11.64 percent, the GDX was down by 14.50 percent.

And when you compare junior gold equities, as measured by the Market Vectors Gold Junior Miners ETF (NYSE Arca: GDXJ), the spread differential jumps to an incredible 49 percent. Indeed, the GDXJ, which tracks the performance of junior gold mining stocks, was down a staggering 37 percent in 2011.

Why have gold equities underperformed bullion across the board? And why have they underperformed by such a wide margin in 2011? More importantly, what can we expect from the miners in 2012 and beyond?

Rising Production Costs

Putting aside pop culture images of gold bullion vaults in James Bond movies, the gold mining industry is a tough, dirty and capital-intensive business. To produce a mere kilogram of gold requires digging up large amounts of rock from the earth: For every five to 10 grams of gold, you have to extract about one metric ton of rock.

That requires heavy machinery, long man-hours, transportation and transformation costs. Mining in general, and gold mining in particular, requires lots of time and money. And costs have been increasing across the board: Labor, machinery/equipment and energy costs are all on the rise.

Increasing Labor Costs: The Wall Street Journal recently ran a front-page story about how miners in Australia are now earning more than $200,000 per year for doing basic manual labor such as operating cranes. The mining industry is suffering from a worldwide deficit in skilled labor that can do the routine tasks involved in operating a mine. This lack of qualified mining professionals means the mining companies’ costs for labor are increasing dramatically and cutting into profit margins.

  • Increasing Energy Costs: Energy is a big component in operating a mine, and can range anywhere from 25 to 50 percent of total input costs for mine operators. You need fuel to operate the heavy machinery, electricity to keep the surrounding operational camp running and for other critical factors such as refining procedures. With oil costs rising across the board in 2011, it’s no surprise that mining company margins have been decreasing quite significantly.

All in all, cash costs for gold mining companies are experiencing a dramatic rise. Based on my calculations, average cash costs for many operators increased by about 60 percent since 2007, with many operators seeing their cash costs double over this time frame. In countries such as South Africa, cash costs are so high that they’ve hit almost $1,000 per ounce.


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