There are an increasing number of analysts and observers calling for an imminent rally in the price of gold stocks, and although I believe they will eventually be proven right, I think those placing bets today may have to wait for a while yet.
The fact that gold stocks are currently lagging the bullion is well documented and is primarily because sometimes gold stocks act like stocks, and sometimes they act like gold stocks, i.e. derivatives of the metal. Right now gold stocks are acting like any other stock and are selling off with the rest of the equity markets. The reason I think that the stocks will continue to lag the bullion however, is only partly explained by these phenomenon.
Chart of GLD (the gold ETF) vs four of the largest gold miners: Coeur d’alene Mines [CDE], Hecla Mining [HL], Barrick Gold [ABX] & Newmont Mining [NEM]. Timeframe: 25 April – 18 Aug 2011. Source: Google Finance.
The other reason has to do with the yellow metal itself. Gold is a somewhat unique asset in that it is driven by both greed and fear and what’s driving gold right now is fear. Investors (and to some extent the public) are buying gold as protection from a plethora of economic and financial ills – everything from inflation fears in China, to debt default fears in Europe to, currency debasement fears in the US.
When investors are in fear mode, as they are today, they aren’t looking for return ON their capital, they are simply looking for the return OF their capital. In this environment gold becomes the asset of first resort.
I do however believe that the stocks will have their day, only not just yet. There are two big events out there on the horizon that I believe will provide the catalyst for the miners’ eventual catch-up. The first will be when gold punches through $2,000. This will draw a lot of attention to the sector and the profitability of the miners – especially since the price of oil as dropped. With gold at $2,000 an ounce these companies will be quite literally minting money and it’s then that the greed driver will begin to kick in.
The second catalyst I see is the announcement of more QE, which in my opinion is likely to be a coordinated effort by the Fed, ECB, the BoJ, the BoE and others. This will be true shock and awe. Expect multiple trillions. Gold’s response to this announcement will be a huge surge in price but crucially for the stocks, fresh monetary stimulus will provide a boost to all risk assets.
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