So Why Have Gold Stocks Performed So Badly Versus The Actual Metal?

Gold stocks, as measured by the HUI Index, are at their cheapest level in almost three years relative to the price of the actual metal. The question is: Why have gold stocks performed so badly versus the actual metal? And what does this mean for those investing in the sector?

The chart below shows the HUI:Gold ratio which indicates the performance of the gold shares relative to the price of gold itself.

A 3 Year Chart Of The HUI:Gold Ratio

Chart courtesy of

At the climax of the equity market selloff in March of 2009 the HUI:Gold ratio briefly reached 0.2843, today the ratio is only marginally above that level at 0.302. What this means is that those companies included in the HUI index are as cheap relative to gold, as they were when the FTSE and the DOW were trading at around 3,530 and 6,626 respectively.

Over this three year period there were three distinct periods. Coming off the March 09 lows the stocks actually outperformed the metal. Then, from late 09 to early 2011 the ratio traded in a broad range. However since April 2011 the gold stocks have fallen dramatically versus the bullion.

So why haven’t the stocks kept pace with the bullion?

Perhaps the biggest single reason the gold mining stocks haven’t kept pace with the rise in the price of bullion, is that 2011 was a year characterised by a flight to safety rather than an appetite for risk. This meant that gold stocks were sold along with general equities as investors moved their money into cash, government bonds and gold. This move fuelled a huge rise in the price of bullion, with the yellow metal rising from $1,309.10 in January 2011 to an all-time high of $1,923.70 in early September, a rise of over 46%.

Another important reason for the outperformance of the bullion has to do with the ratio spread trade. This is a tactic that the hedge fund world began using around 2006, in which they go long the metal (or the ETF) and go short a selection of the gold shares. The funds target the weaker gold stocks that have been dragged higher along with the overall sector, and it’s a very profitable strategy.

A third factor that has long hampered the performance of the shares relative to the metal was the introduction of gold ETF GLD back in November 2004. GLD provides hedge funds and other large players with a way to gain leveraged exposure to the price of gold without the need to own the mining shares. All they have to do is own GLD on margin. This introduction of GLD siphoned money out of the mining shares and it is yet to return.

A Closer Look At The HUI Index

The HUI (also known as the NYSE Arca Gold BUGS Index) is the most widely followed index of companies involved in gold mining. The index is designed to provide significant exposure to near term movements in gold prices by including companies that do not hedge their gold production beyond 1.5 years.

Companies Included In The HUI Index

Chart courtesy of – Index components as of 1 December 2011

There are some companies within the HUI index that have performed well over the past 12 months, however the majority have either gone nowhere or have fallen considerably.

Among the worst performers are Hecla Mining which is down 52% over the past 12 months, Kinross which is down 33%, Iamgold which is down 23%, and Eldorado Gold which is down 22%. Agnico-Eagle is also down 49% after taking a $644 million writedown on its Meadowbank project in northern Canada.

The best performers include Yamana Gold which is up 33% over the past 12 months, Randgold Resources which is up over 35%, and New Gold which is up 22%.

What does it all mean?

What all this means is that those looking to invest in gold mining equities really need to do their homework. Simply buying an index is unlikely to provide leverage to the metal. Personally I see more upside in the smaller producers rather that in many of the large cap names found in the HUI. It’s for this reason that I favour funds such as Black Rock Gold & General which has recently increased its focus on higher quality, mid-tier producers.

The Black Rock Gold & General fund

The Black Rock Gold & General fund, the biggest gold fund available to UK investors, can be held inside a Stocks and Shares (Maxi) ISA and is managed by Evy Hambro. The fund has recently reduced its exposure to those companies that may be required to raise capital in order to develop their projects and it has increased its holding of gold royalty companies, both of which are excellent strategic moves.

The fund’s performance speaks for itself: £1,000 invested in the fund in 1999 would now be worth £12,436 (as at 31 May 2011 if invested in an ISA.

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