Wednesday, August 24, 2011

The case for Gold Miners vs Gold

Gold has been on a roll for many years but has especially gone up in a parabolic manner recently even though the expected correction seems now underway, actually a bit earlier than initially expected.

Gold miners have also gone up, but in no way as fast as the gold itself, as you can see from the 5-year chart below with SPDR Gold Trust (GLD) in Green , Market Vectors Gold Miners ETF (GDX) in Blue and AMEX GOLD BUGS INDEX (^HUI ) - the underlying tracked by GDX - in Red (Source: Yahoo Finance)


As you can see gold itself has clearly outperformed gold stocks in the last 5 years. Another important thing is that GDX tracks the HUI index pretty well. Whether an ETF can properly tracked the underlying index should be always be checked before investing in an ETF as some ETFs are poorly constructed and only designed to make money for their manager(s) or short term traders.

We can look back in history with the BMGI (Barron Gold Mining Index) to Gold price ratio and clearly see that relative to the price of Gold, Gold mining shares are historically still very cheap as you can see on the chart below (Source: 321gold.com).


This chart only shows the ratio until Q1 2010. In August 2011, the BMGI stands at 1394 and the Gold Price is around 1750 USD, so the ratio is around 0.80 which is close to historical lows (around the lower red line).

However, you can also notice that in early 80s, the ratio was also very low during the gold spike. That means that during the 1980 Gold bubble, Gold miners stocks did not go up as fast as gold either.

To conclude, if the current Gold bull market is not over, it could be a very good time to buy gold miner stocks. But if the Gold bull market is over, gold miners could still lose value albeit less than gold bullion.

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