With a positive gold outlook are gold miners attractive?

If we look at the gold market since early 2004 we can see that gold spot has been a fantastic trade outperforming the global equity market delivering 9.2% annualized return. In the same period global equities have delivered 6.3% annualized. One would think gold miners would be attractive given their leverage on the balance sheet providing investors with a leveraged play on gold spot. History suggests this is a myth and that gold miners apparently have difficulties delivering a value add for shareholders beyond the selling price of the actual commodity. Gold miners have returned 3.6% annualized since early 2004 and the industry leader Newmont has delivered 3.7% annualized hardly beating the global inflation.

Two things have hit gold miners hard since the gold price decline started back in 2013. The 13 years leading up to this regime shift in the gold price was one long march higher bolstering profits and likely causing the same illness as we observe among oil producers today; namely too high costs and inability to change the cost structure to lower gold prices. In addition to high operating costs the ESG (environmental, social and governance) theme rose to prominence on Wall Street with an entire investors class suddenly demanding ethical business practices to receive both index inclusion and investor money. Gold miners are not exactly top of the lists of ESG companies and thus the valuation spread to the global equity market has come down over time.

History tells us that gold miners do not provide any value add beyond gold spot so investors and traders should just focus on gold spot. Liquidity is also better in gold spot which is attractive. However, there is one main risk owning physical gold, most likely through an ETF, and that’s the risk that governments might make private gold ownership illegal if governments suddenly cannot control inflation following the current monetary and fiscal stimulus. This thesis was presented last week by hedge fund manager Crispin Odey.