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Gold mining equities and Unfulfilled Promises

March 30, 2012 by · Leave a Comment, gold and more gold. Yet again the precious metal is worth talking about. The current divergence and uncertainty emblematic of this metal is overwhelming, and at the end of the day we just don’t know where spot prices are headed. In considering the lagging demand of our biggest consumers of gold, namely China and India, we are faced with factors that could pull prices down in the near term. Of particular concern is the Indian government’s recent decision to double taxes on gold imports, the effects of which are yet to be seen. There are also fleeting glimpses of a US economic recovery, where a potential strengthening of the US dollar could further weigh against demand. On the other side of the equation there is more than enough reason to believe prices will rise. Goldman Sachs has predicted gold could top $1,840 an ounce within 6 months, and $1,940 by next year. Factors in favor of such include shallow growth, higher futures, weakening currencies and the potential to see the Federal Reserve embark on a new round of monetary policy loosening.

But in discussing gold mining stocks, the price of gold actually becomes irrelevant. Because in spite of the gold boom, investors have been cursed with gold stocks that seem to consistently underperform. And that makes investing all the more difficult. John Corcoran, Oppenheimer Funds vice president, notes that “we are in the 12th year of a bull market for gold, and it has an average annual return of 18 percent per year”. He goes on to state that he “prefer[s] investing in gold-mining equities”, because now, more than ever before, they boast cheap prices in comparison to gold. But that is where it gets interesting. Why are they so cheap?

Well, it’s because nobody wants to invest in them. From November 2011 to March of this year, $3.75 billion has flowed into U.S. commodity precious metals, including gold, whilst $850 million has actually flowed out of equity funds. Tom Roseen, senior analyst at Lipper, notes, “we have not previously seen that kind of trend of consistent outflows from the gold and precious metals equity funds”. Today’s valuations of gold mining stocks have fallen to levels unseen in the last decade. And it is perplexing, because according to the Mineral Commodity Summaries 2012 submitted by the US Geological Survey, the world’s gold producers increased 2011 output by as much as 5.5 percent from the year prior. And today, where gold prices stagger close to their 52-week highs, gold mining stocks barely linger above their 52 week lows.

There are several explanations for the latter, one of which was the implementation of exchange-traded funds (ETF’s) just over 5 years ago. These have permitted easier investments into gold and other metals, and have made the gold-equities option less compelling over the years. The political uncertainty associated with mining abroad has also acted as a further detriment to the allure of gold mining stocks. For instance, Newmont Mining Corp (NYSE: NEM, TSX: NMC) is currently facing difficulties at its mines in Indonesia and Peru, because the respective local governments are looking for a greater share of their mining profits. Resource nationalism is equally imposing its will on many different miners worldwide, forcing them to push up costs. Tom Kendall, of Credit Suisse, notes, “if you’re struggling to control costs and if the perception of investors is that the political or operational risk is rising in the areas in which you’re operating, then you’re facing an upward battle”.

Yet another problem stems from criticism of mining executives themselves. In the wake of growing output they are failing at providing adequate incentives for investment in gold mining equities. Rob McEwan, chief executive of McEwen Mining Inc, singles out Goldcorp, and suggests that while the price of gold has risen 133 percent in the past 6 years, the company is still trading at 2006 prices. He argues that gold miners need to offer greater dividend payouts to their shareholders. “If the seniors came along and started paying a 3 or 4 percent yield, they would broaden their appeal in this yield starved market”.

And so, alarmingly, in a cycle that has seen gold prices consistently rise; there has been little relative payout to those investing in gold-mining stocks. As a result the pursuit of stock options has become much more difficult. It would require a balancing assessment of foreign political environments, financial returns, and dividend payouts. In gold mining equities, the actual price of gold means very little.

Jason Staeck

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