Gold vs gold stocks

Things seem to be getting back to normal in Vietnam, especially in HCMC. The market is up, which is interesting, because it’s not like the economic impact is over, but I guess people are optimistic.

As I was thinking about the market, I read this article about how gold miners were beating out tech stocks in the pandemic. For a long time, I thought I wanted to cover miners and other commodity plays, and this article brought back some of that (weird) love for the companies. Miners are interesting, because you think you are buying exposure into the underlying commodities, but you can often be wrong. Remember, for a long time, there weren’t ETFs or other financial products that so easily tracked commodities, and miners were the only way to buy gold (besides getting a coin or something). Not you can buy gold, a gold ETF or a gold miner. And each of these has very different properties and exposures.

Source: Yahoo finance, chart by Vietecon.com

That actually is key. Because the exposure a gold miner provides can be quite different from a gold ETF or a gold coin. Take a long at this chart of 6 gold miners versus the price of gold (GC). It tracks it somewhat, but in a more leveraged fashion.

Why do people buy gold? I have heard so many reasons, but I still can’t really wrap my head around it. Maybe because I have too much (undeserved) faith in reserve currencies? Gold has held its value (meaning that it is still a valuable thing to hold) for millennium. And in countries with hyperinflation, people hold gold or other safe assets as a hedge. The rule of thumb is that in bad times, people buy gold as a safe haven. The problem is that these days, most people buy gold assets (like ETFs) not actual gold, so if everything really breaks down, owning a piece of paper that says someone owes you 1/57th of a gold bar probably won’t help you get bread.

All stocks listed by ticker. GC = the price of gold. Source: Vietecon.com

Anyway, gold prices have risen: 30% yoy and 12% ytd. So that should mean that the stocks are up, which they are. But I was surprised that day-to-day fluctuations don’t really depend that much on changes in the gold price. I did a simple calculation of how many days all 6 stocks and gold increased (and how many days all decreased). In only 93 of 251 trading days over the past year did all six stocks and gold trade in the same direction. Let’s assume there are a lot of variables for the companies, but even if we lower it to 5 of the 7 trending in the same direction, that only happens 145 days out of 251.

Source: Vietecon.com

Basic correlation isn’t all that great either. The gold stocks themselves are fairly highly correlated (some more than others), but the stocks with gold are all below 50% (see the chart up to the right, GC is the price of gold).

Then I did a simple regression of each of the six stocks versus gold, and gold only explained something like 10-20% of the change in the stocks. On average it was 14%, but it went as high as 0.21 (GOLD) and as low as 0.08 (GFI) - see chart up the right.

Why is so little of the change in the stock price explained by changes in the price of gold? Let’s step back and consider what stocks are. One simple way to think of them is that they are an option on the company’s free cash flow, with debt being the strike price. Anything above that, and you make money, anything below, and you got nothing. Apply that to miners: when gold goes up, that means cash flows increase (hopefully above the amount of debt owed), and the levered bet on the company is attractive.

But company specific issues can really drive performance even more than the gold price. Maybe workers at one of these companies had health issues caused by COVID-19, or it has problems getting gold to the market because of supply chain issues.

Also, the companies generally own the mines, and so the may slow down mining when prices are low and do more when prices are high. So it’s highs are higher than gold and its lows are lower.

This bring us to a basic point about investing: you could be right about a trend and still not make money. In this case: gold prices will go up. But investing around that thesis might not be as simple as buying gold stocks. Sometimes it will be, but not always, and the company that you choose will matter a lot. For example, looking back at my first chart: if you had bought Agnico Eagle Mines, rather than any of the others at the start of the year, you would have underperformed. And if you bought Barrick in late February, you would be underwater now, despite gold being slightly up!

That’s why investing is so hard.