Why Gold Miner ETFs Have Lagged Gold Prices

February 14th at 11:20am by Tom Lydon

Gold mining stocks and exchange traded funds have consistently lagged the run-up in gold prices. Although the two seem they would be in agreement tracking the price of gold, there are a number of reasons why they tend to diverge.

“Gold miners do not perfectly track the price of the physical commodity. Most of these companies have significant operating leverage, which can magnify the effects of fluctuating gold prices on their profitability. They also add a layer of political and operational risks that investors in the physical commodity do not face. For example, in recent years, several of the fund’s mining operators misallocated resources by running low-return mines that did not cover their cost of capital,” Alex Bryan wrote for Morningstar.

The Market Vectors Gold Miners (NYSEArca: GDX) provides investors direct exposure to the price of gold by investing in the companies that mine the metal. So a gold mining ETF investment is an equity play, rather than a physical commodity. Conversely,  the SPDR Gold Shares (NYSEArca: GLD) is an investment in the physical commodity that is held in vaults. There are no futures contracts, indicating this is a pure play on the price of gold, reports Investopedia. [Five Reasons Why Gold ETFs and Miners Could Shine in 2013]

Over the past two years, GLD has gained 23%, while GDX has lost 25% . The Market Vectors Junior Gold Miners ETF (NYSEArca: GDXJ) tracks smaller gold mining companies, and has lost about 49% over the same time period.[Defensive ETFs to Shield Against the Fiscal Cliff]

Another reason miners have not kept pace with the metal is due to lack of investor demand or interest. Investors will invest in miners if they think the value of gold is going to rise. Many of the major hedge funds and institutional investors have not poured a lot of capital into miners since many analysts have predicted the price of gold will drop in the intermediate future.

Gold mining companies have not typically been good at managing capital. They have kept dividend payouts to a minimum, re-invested in lukewarm projects and issued new equity in order to finance acquisitions. Costs can go up in countries when one considers the tax implications, regulatory hurdles, and cost to run the mining company by qualified employees. This all eats into the profit of a mining company. [Has the Gold ETF Bull Run Its Course?]

Historically, when miners have lagged the price of gold for an extended time period, they do give investors a cheap way to gain exposure to gold. Plus, the potential to outperform becomes greater, reports Bryan. Gold miners are looking attractive in price in comparison to gold bars, and value focused investors are starting to surface. Plus, as more of the larger mining companies become heavy on cash due to the run-up in gold prices, gold miners will raise their dividends and should  become more attractive to potential investors.

Other miner plays:

  • Direxion Daily Gold Miners Bull 3x Shares ETF (NYSEArca: NUGT) Plays the NYSE Arca Gold Miners Index and magnifies the movement times three.
  • Direxion Daily Gold Miners Bear 3x Shares ETF (NYSEArca: DUST) Plays the NYSE Arca Gold Miners Index and seeks daily investment results of 3 times the opposite performance.

Market Vectors Gold Miners

GDX, GDXJ, GLD, DUST, NUGT, Gold, Gold Miners, Commodity ETFs, ETF, Precious Metals

 

Tisha Guerrero contributed to this article.

Full disclosure: Tom Lydon’s clients own GLD.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.