Structure Matters: Factors That Drive Gold Miners

Structure Matters: Factors That Drive Gold Miners

Could imbalances created by years of quantitative easing lead to a rally in gold stocks?

Reviewed by: Dan Weiskopf
Edited by: Dan Weiskopf

This column is part of a new collection of our “Structure Matters” series of interviews with leading ETF and index industry figures. They are conducted by Dan Weiskopf, a portfolio manager at New York-based Access ETF Solutions LLC. In today’s piece, Weiskopf interviews Joe Foster, who is a gold strategist and portfolio manager at Van Eck Global, the firm behind the large-cap gold mining ETF Market Vectors Gold Miners (GDX | C-78) and the Market Vectors Junior Gold Miners ETF (GDXJ | C-48).


Given Foster’s expertise as the firm’s active gold mining mutual fund portfolio manager, we thought it would be valuable to sit down with him regarding what factors might be a catalyst to drive gold mining stocks.

Dan Weiskopf: In the short and long term, what factors should investors be looking for as catalysts for small- and large-cap mining companies?

Joe Foster: Historically, gold stock indexes have had a high correlation with gold. Therefore, movement in the gold price is the primary driver of gold stocks. The price of gold bullion is driven by risks to the global financial system, and especially the U.S. financial system.

Gold has been in a bear market since 2011. This sector is out of favor and most of the selling pressure has probably run its course. As we believe gold is forming a base in the $1,150-$,1300 range, we look forward to catalysts that might increase financial risk and drive gold higher.

In the near term, the anticipated Federal Reserve rate action could prove a turning point for gold, as well as other markets. Will the Fed have the conviction to raise rates? Can the U.S. and global economies withstand a rising-rate environment? In the longer term, we believe the radical fiscal and monetary policies of the past decade could bring unintended consequences.

Global imbalances brought on by quantitative easing, ultra-low interest rates and massive accumulations of sovereign debt, in my view, have the potential to create dangerous asset bubbles and misallocations of wealth. The current U.S. expansion is six years old, and no previous expansion has lasted longer than 9.5 years. Perhaps the next downturn will expose these embedded financial risks.

Weiskopf: Could this sector be considered reasonably valued over historic metrics? What are those metrics? Should we be looking for more consolidation in the group of stocks you follow?

Foster: Gold stocks are undervalued by historic metrics. Price to cash flow and price to net asset value (“NAV”) are the most commonly used valuation metrics, and both show stocks below long-term averages. Gold stock/gold ratios are also at or near all-time lows. (NAV values companies using discounted cash flow methodology.)

Mergers and acquisitions activity is an ongoing feature of the gold sector. Companies combine to gain financial strength or operating synergy. Producers generally look to smaller companies to sustain their production. I think consolidation will proceed at the same pace we have seen during the past couple of years. It could pick up once the current gold price gets moving higher and if valuations move to more normal levels.

Weiskopf: Can you put into context how you view the order of the factors that might drive price performance for your sector?

Foster: The price of gold is the primary driver, as I said earlier. Financial stress, or “tail risk,” are significant drivers, and this can come from many places—inflation, deflation, currency turmoil, banking problems, etc.

Anything that places undue stress on the financial system can be a catalyst for gold and gold stocks. There is a strong negative correlation between the U.S. dollar and gold, so gold usually has a tough time when the dollar is gaining.

Other supply/demand factors that generally influence gold are physical demand (mainly from Asia), central bank demand, scrap supply and mine supply.

All of these factors have been supportive and are helping gold to form a base. Physical demand from India and China has been firm. Central banks have been net buyers for several years. Scrap supply is down and mine supply is expected to peak by 2016.

Weiskopf: Should investors look at the gold miners as beta to gold price?

Foster: Gold stocks have a high correlation to gold, and they normally provide leverage or “beta” to the metal. The beta typically comes from their earnings power, in-ground resources, potential discoveries and operating improvements.

Over the past decade, the beta has been higher on downside than upside moves in the gold price. As a result, many companies have underperformed gold. This was caused by tremendous cost inflation that put a squeeze on profits and disappointed investors.

Many of these factors have changed as managements have implemented cost controls and engineering improvements that should help to preserve margins going forward. As a result, we believe the companies will carry higher betas going forward, especially on the upside.

Weiskopf: A key factor with balancing the supply/demand equilibrium in the gold mining sector has been central bank transactions. What countries should we be focused on in the near term as a catalyst?

Foster: Central banks have been strong buyers recently, with 2014 as the second-strongest year on record. Russia has been the biggest purchaser. China doesn’t report official gold holdings, but it is widely believed it has been accumulating gold. It last reported in 2009, and many expect China to become more open as it seeks to establish the yuan as a reserve currency. This could become a catalyst for gold.

Weiskopf: Is the price of oil a factor to watch for profitability in the mining area and as a factor that is correlated to gold price?

Foster: Like many other sectors, oil sometimes correlates with gold, but it is an indirect link that is highly dependent on other factors that are going on in the economy and financial system. So it has generally limited value as a predictor. Gold mines, especially open pits, are significant energy consumers. Fuel can be up to 10 percent of a mine’s cost, so low oil prices have had a positive impact on costs in 2015 to-date.

Another area of cost savings are weak currencies globally, especially in Latin America, Australia and Canada. Gold is a dollar-based commodity, so weak currencies reduce the cost of locally derived labor and materials in U.S. dollar terms.

At the time of the interview, the interviewer’s firm didn’t own any of the securities mentioned. Dan Weiskopf is a portfolio manager of Access ETF Solutions LLC, whose third-party ETF strategies are offered through IPI Wealth Management, Inc. (IPI). IPI is an SEC-registered investment advisor, with its principal office located at 226 W. Eldorado St., Decatur, IL 62522, 217-425-6340. Access ETF Solutions LLC was established in 2013 with a focus that structure matters in selecting ETFs. Access ETF Solutions LLC is not affiliated with IPI. Readers are advised to read the full transcript of the interview, including disclosures at, or contact Dan Weiskopf at 212 628-4882.

Dan Weiskopf is a Toroso portfolio manager and member of its investment committee. He has over 30 years of portfolio management experience, with almost 20 years as an ETF strategist. Dan is often quoted as saying that "structure matters" more in selecting an ETF than simply its fee.