Gold stocks: A leveraged play
Gold miners’ stock prices are usually leveraged plays on gold prices. When gold prices fell 11% in 2015, the VanEck Vectors Gold Miners ETF (GDX) amplified that loss by returning -25%.
This year is different only in terms of direction, with GDX amplifying gold’s gains positively this time. The higher the ETF’s correlation or leverage to gold prices, the higher the impact on stock prices.
This leverage led GDX to fall 17% in November, compared to a fall of 8% in gold prices in the same period. As we’ve discussed in the previous parts of this series, the short-term outlook for gold doesn’t seem so bright given the strong US dollar and the Fed’s impending potential rate hike. It’s important to analyze how gold miners would perform under such a scenario.
Gold miners-to-gold ratio
First, let’s see what the gold miners-to-gold ratio is saying about gold miners. The ratio shows how many shares of a gold index one ounce of gold can purchase. This shows miners’ values relative to gold’s price, which can be used to assess whether gold and gold miners are undervalued or overvalued relative to one another.
The ratio of the NYSE Arca Gold BUGS Index (or HUI) to gold ratio bottomed out at around 0.15 in 2000, meaning that an ounce of gold could have bought a 0.15 share of HUI. This ratio meant that miners were quite cheap compared to gold. In 2003, this ratio peaked at 0.64.
At the start of December 2016, this ratio was 0.16. It peaked at 0.21 in August 2016. Compared to their long-term histories, gold miners are quite close to reaching the bottom relative to gold’s value. Usually, this would mean a reversal in gold miners’ prices compared to the long-term average. However, investors should note that these miners could remain undervalued or overvalued for an extended period of time.
To gain exposure to higher leverages, investors may want to consider gold miners, especially at such undervalued levels. Gold miners have become leaner by reducing their costs and debt levels in the last few years as gold prices have remained under pressure. These miners include Barrick Gold (ABX), Newmont Mining (NEM), Kinross Gold (KGC), and Yamana Gold (AUY).