Diverging Performance

As 2011 closed, the market experienced a gaping difference between gold stocks and physical gold. Specifically, while gold bullion prices in 2011, as measured by the SPDR Gold Shares ETF (NYSE: GLD), were up 11.64 percent, gold equities, as measured by the Market Vectors Gold Miners ETF (NYSE: GDX), were down 14.50 percent.

Fast-forward to today, and the divergent performance between GLD and GDX still exists. While GLD is up 6.14 percent year-to-date, GDX is down 9.71 percent. Going forward, expect this divergence to continue and, for the reasons below, gold bullion will continue outperforming gold equities for the rest of 2012.

Volatile Stock Markets

Gold stocks are just that, stocks that are traded on global capital markets on a daily basis. As such, they are treated by investors first as stocks, and then as physical gold proxies. Ever since the financial crisis of 2008, global capital markets have never fully recovered their previously steady state of affairs. Since 2008, markets have been characterized by extreme and unpredictable volatility.

Let’s use initial public offerings (IPOs) as a measure of market stability. Prior to 2008, the NYSE and Nasdaq had a steady and certain stream of IPOs coming to market. Since 2008, the number of IPOs has dropped off a cliff, down some 40 percent and, even more alarming, is the number of canceled IPOs — companies who were prepared and geared up for an IPO but were forced to postpone or even cancel their stocks sales due to volatile markets….

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Canceled and postponed IPOs provide a dramatic and clear view of the volatility that has been plaguing financial markets. Very few segments of the market have been spared, including commodities and mining. Mining equities, especially gold miners, have been depressed by this market volatility, fueling the underperformance relative to gold bullion.

Unfavorable Economic Conditions

In addition to volatile markets, economic conditions for mining companies have also created head winds for earnings and revenue growth. Even though demand for physical bullion has remained steady, operational costs have been increasing keeping mining company earningd down. Costs such as:

• labor costs are increasing due to a lack of qualified mining engineers, workers and operators,
• energy costs, which can make up more than 50 percent of operational costs, have been steadily increasing as well and, finally,
• many mining jurisdictions are tightening environmental standards so that mining companies are spending more on environmental permitting and licensing.

These extra operational costs are eating into mining company earnings and when you couple that with volatile global equity markets, it’s no surprise that gold equities have underperformed gold bullion.

Gold Bullion

On the other hand, demand for physical gold has been very steady and has even experienced a persistent increase on a quarterly basis [for the following reasons]:

• Gold is seen as a safe haven by investors. In an environment where governments are printing lots of money to stimulate stagnant economic growth, investors are turning to the yellow metal as a reliable store of value. Ironically, volatility is at the heart of gold-stock underperformance and strong demand for gold bullion.
• Demand from Asia, especially China and India, has been increasing as rising incomes in the region are causing more physical purchases and
• central banks have become large purchasers of bullion, which results in large purchases that create a floor for prices.

Conclusion

All in all, gold bullion will continue to outperform gold equities for the rest of 2012. One way to benefit from this trend is to go long GLD while simultaneously shorting GDX.

*http://www.hardassetsinvestor.com/the-commodity-investor/3682-the-commodity-investor-gold-stocks-will-continue-to-underperform-gold-bullion-in-2012.html  (To access the articles please copy the URL and paste it into your browser.)

Editor’s Note: The above article may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.

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