Contrarian Case For Precious Metals Equity

July 29, 2015

It's been a bloodbath for precious metals equities (PMEs). PMEs are companies that mine gold, platinum and other precious metals.

While gold is down 8.4 percent over the past five years ending July 24, 2015, PMEs are down far more. The Market Vectors Gold Miner's ETF (GDX | C-78) has lost 70.2 percent over the same period, while the Vanguard Precious Metals and Mining Fund (VGPMX) is down 56.8 percent. Both are with total returns, including dividend reinvestment.

Source: Yahoo Finance including dividend reinvestment

And it's just not recent performance that's been so abysmal.

Financial author and theorist William Bernstein says that Ken French’s Precious Metals Equities series (spliced with GDX return YTD) returned a dismal minus 0.13 percent real return from 6/30/63 through 7/27/15. Thus, unlike gold itself, precious metals equities haven’t kept up with inflation.

What's Gone Wrong?

Why have PMEs done so much worse than gold itself? There are perhaps several reasons.

First, their profitability is much more sensitive than the price of the metals themselves. Since there are costs to mine, a 10 percent decline in the price of gold could have a 20-30 percent hit to their profitability.

Next, these stocks are typically levered, so their debt service adds more stress to the bottom line. Further, many of these mining companies are located in South Africa and have gone through violent strikes. Finally, many of these companies have been called poorly managed. When gold prices surged, many built a cost structure that assumed they would stay high or continue to surge.

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