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4/11/09

Gold and gold miners: A chart study of correlations


Yesterday in the comments section of this post, reader Pedro Candela asked.......

"which gold companies' shares would you recommend to buy that have a very good correlation with gold bullion prices?"

....and as I hadn't looked at the relevant charts of gold versus the gold miners for a while this interesting question piqued my interest. What we're trying to gauge here is beta correlation to gold, but that's just a fancy name for the leverage a gold mining company has versus its major product.

The subject of this post is hardly new, of course. The "gold vs gold miners" debate has been going on since before I was born and will go on long after my time is up. But all the same, here follow a few thoughts that came from the charting inspired by Pedro's question and a few charts themselves. Firstly, we need to narrow down the wide range of miners on offer. Logic suggests that to get a fairly close correlation to gold, a gold miner must be:

1) Big, most probably a tier 1 miner, possibly a tier 2. This rules out a lot of the small producers (Troy, Metanor, etc ad infinitum) that get pushed around more by their own local circumstances.

2) Stable, so companies that have a short company history (i.e. recent start-ups like JAG) or a patchy record in the non-production part of company life (DROOY springs to mind) don't interest us.

3) Mostly gold. The company should make as much of its revenue as possible from gold and only gold. Silver revenues, as long as they aren't too big, don't skew things too much but a big reliance on other metals isn't the ideal. So a company such as Freeport (FCX) is left out as it makes most of its money from copper, even though it churns out plenty of gold ounces.

4) Unhedged (or mostly unhedged) on production so that market movements of gold are better reflected in the company itself. Nowadays this doesn't tend to be a big issue.

So here we go with the charts. Be warned that they may look "messy" at first sight, but believe me they could have been a lot worse! This is because I've narrowed the field down to just eight gold companies, namely...
  • Yamana Gold (AUY)
  • Buenaventura (BVN)
  • Newmont (NEM)
  • Gold Fields (GFI)
  • Goldcorp (GG)
  • Kinross (KGC)
  • Barrick (ABX)
  • Royal Gold (RGLD)
...as representatives of their sector. If I've missed out your fave gold play, sorry, but you can always run the same chart exercise with your own parameters.

All the above gold mining plays are then compared to GLD (the gold ETF) which acts as an excellent proxy to gold itself. Please note that all companies are quoted on their USA tickers so that exchange rate issues are discounted. Also please note the line for GLD is that black one made up of broken daily trading highs and lows (called the OHLC) while the other tickers are the unbroken, coloured lines. Finally, click on any of the charts to get a bigger view.

Firstly, a very interesting set of three charts that compare all nine tickers over three time periods. This chart for 2009 only (Jan 1st to date);

Next this chart below from November 1st 2008 to date;

Thirdly this chart from September 1st 2008 to date;

These three charts looked at in conjunction make it clear that the timescale involved is most important, this is because the gold miners are almost to a man levered to the price of gold, and some display heavily leverage (or beta).

If we focus in on the "Sept 1st to date" chart above, we see that the price of gold has done comparatively better than all but two of the miners. This is because the time period takes into account the September and October 2008 big swoon period when stocks of all types dumped heavily, but gold was supported by people moving into it as a safe haven option. However by looking at exactly the same companies but starting the ball rolling at November 1st, that bad period is behind us and the miners have bounced back well, with all of them outperforming the metal. And by way of exaggeration to prove a point, we can take a look at the Sept-Oct 2008 segment of time in isolation and see just how those gold stocks were slammed compared to gold:

Gold went down 10% in that period, while the miners dropped 40%, 50% even 60%. That's a nasty pill to swallow in just two months if you bought gold miners "for safety" and really is the crux of the whole matter; miners do typically display high beta correlation to gold. The mining companies will sometimes match the percentage moves in gold quite faithfully. Sometimes they will outperform gold by a lot. And sometimes they will underperform against gold. It all depends on the internal state of the company, the external state of the economy and a thousand other factors, not necessarily gold itself.

Here's the one year chart with the same comparisons........
........and we again note that gold the metal beats out all but one of our examples, a direct reflection of the 2008/2009 bear market.

And here's an altogether longer, four year view.....
.....and perhaps this four year timescale above gives the best understanding of which gold company is the "best match" to gold the metal. After studying it for a while you'll probably come to the same conclusion as I and choose Royal Gold (RGLD) as the best fit. Here's the same four year chart that isolates RGLD versus GLD:
In the end it's not that surprising that RGLD matches GLD's movements in the most faithful manner, because RGLD is a gold royalty company and not a true miner (check the company website to see what I mean if you're unsure). But even then, if we go back to the one year chart above we note that RGLD has displayed strong positive leverage to gold for the last 12 months.

The bottom line to all this is really two separate conclusions:

1) The timescale of the study is of the utmost importance. Gold companies act differently to their metal product depending on wider circumstances. So when, for example, a company representative boasts that their company has outperformed gold or the market or whatever by X percent in the last X weeks/months/years, unfurl that red flag!! Don't just swallow the IR guy's timescales whole but check his company against a whole range of times and perhaps against a range of peers, too. It will give you a better idea about the company's true performance.

2) Gold miners offer significant leverage to gold. Period. If you buy the miner it means you're getting extra bang-per-buck on the forward movements of gold itself. The miners are also affected by the foibles of the people that run them, errar humanum est and all that jazz. So don't fall into the trap of thinking that gold miners are as safe an alternative as an investment in physical gold. They're not. They are far more speculative. And in the end, this is why I hold a chunk of gold bullion in my long-term portfolio and not an equivalent bunch of shares in NEM, ABX, BVN or whatever.

As for a recommendation amongst that lot, Pedro: DYODD!

UPDATE:
Trend&Value picks up the baton. I agree with his final sentence.