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Gold vs. Gold Miner ETFs: Is the Divergence Finally Over?


The sharp divergence between gold miners’ share prices and the gold price over the past two years has caused investors to question whether there might be a fundamental reason behind the relative underperformance of miners.

In this report we investigate recent developments in the industry that might have weighed on gold miners’ share prices performance and assess under what circumstances gold equities may again start to outperform the gold price.

Gold Miners Discount To Gold Price Continues To Rise

Historically, gold miners traded at a premium to most other equity sectors including the broader mining sector, but this is no longer the case. In addition, over the past two years, the performance of gold miners’ share prices have substantially diverged from the performance of gold. [Gold Miner ETFs are 'Most-Hated' Sector]

While there should be a strong relationship between gold miners and the physical commodity, macroeconomic factors have been partially to blame for driving a wedge between company valuations and their main revenue source.

As the gold price has been driven by concerns about currency debasement and European sovereign risks, these same concerns adversely affected broader equity markets, in turn weighing on gold miners’ share prices.

The sluggish performance of gold mining stocks in recent years contrasts to the broader materials sector performance (Figure 1). Historically, gold miners have tended to outperform gold during periods of rising global business activity, as measured by the US Manufacturing ISM index. Conversely, gold generally outperforms gold miners when growth is slowing and the global economy is in a downturn. However, recently this relationship appears to have broken down (Figure 2). With growth in the US and China now starting to pick up again and most stock markets hitting multi-year highs, gold miners are trading at a 53% discount to gold and 114% below their 10-year average vs gold (Figure 3), causing many investors to wonder whether their undervaluation may be explained by their underlying business fundamentals and management choices and how long this de-rating is going to persist.

Cash Costs and Margins

The cost of producing an ounce of gold has soared at an annual compounded growth rate of 16% over the past ten years. The average cash cost of extracting an ounce of gold from the ground is estimated to have been around US$671 in December 2012 compared to US$151 in 2000 (Figure 4). As the amount of gold in a mine nears exhaustion, mining becomes more difficult and costlier. Higher prices for mining inputs such as energy, labor and equipment have put mining bottom lines under increasing pressure. However, producers’ progressive de-hedging (Figure 5) and the rising gold price have allowed gold miners’ margins to expand, outpacing the rise in cash costs over the past 10 years. With the average realized price increasing at an annual compounded rate of over 20%, gold miners should have been able to secure substantial profits over the years. However, company valuations have continued to languish even as reported margin expansion has occurred.

Exploration: How Much of an Impact?

Reserve replacement is probably the biggest challenge gold miners are faced with and the very high cost of exploration is eroding their profits. According to the Metals Economics Group (MEG), only 99 new deposits containing over 2moz of gold were found between 1997 and 2011, for a total of 743moz of new gold reserves (Figure 7). Those discoveries have replaced only 54% of the gold mined during the fourteen year span1 to 2011, leaving a production gap that has undermined gold miners’ performance over the past years. The challenge for gold companies is that not only are new deposits increasingly difficult to find, but it appears all the easily extractable gold has already been found, as evidenced by the declining trend in miners’ reserves (Figure 6).

Once exploration and project development costs are taken into account, the total cost miners are faced with increases substantially (Figure 8).

As most of those costs are capitalized and treated as an asset from an accounting perspective, the impact on miners’ financials can be distorted, as capitalized costs would not be immediately recognized in the profit and loss account, unlike cash costs. The impact of these costs on miners’ profitability is substantial when one considers that exploration expenditure has grown at an annual compounded rate of over 28% year-on-year since 2001 vs an annual increase in cash costs of 16% over the same period (Figure 8). However, they are not the only cost component to consider. In order to convert exploration into mining and mining into production, miners are faced with new investment and sustaining capital expenditure (Figure 6).

Once that these outlays are taken into account, the cost of producing an ounce of gold almost triples to over US$1,500oz, making mining unprofitable for many companies. Skyrocketing exploration costs are likely one of the key reasons for the underperformance of the gold mining sector on the stock market (Figure 8). However, mining companies have become increasingly aware that lack of transparency and over-budget projects are an issue for the sustainability of the industry. Some of the biggest miners, from Barrick Gold to Newmont, have undertaken drastic changes at management level and embraced a high-margin low-cost strategy. This could bring miners back in favor, reversing the current de-rating process.

The Rise of Gold ETPs

While gold miners have historically traded at a premium to other equity sectors, their P/E ratios have fallen below those of the S&P500 and of the base metal miners. Based on historical P/E ratios2, gold miners are now trading 70% below their 10-year average and 48% below their 5-year average. While the average P/E ratio of the companies constituting the S&P500 and the material sector within the S&P500 dropped by 26% and 40% respectively over the past 10 years, gold miners’ multiple fell by over 70% over the same period (Figure 1).

This trend is unlikely to continue, given the changes that the industry as a whole is undertaking. Although the recent changes in management and strategy will take time to produce a material impact on the industry, with average P/Es now below the mining sector average, current valuations may set a floor to any further de-rating. While poor management, skyrocketing costs and lack of new mine production probably had an impact on the drop in gold miners’ P/E values, the introduction of gold ETPs may also have played a role by giving investors alternative access to the gold price performance. Since the introduction of the world first physically-backed gold exchange-traded product in 2003 by ETF Securities, the gold market has undergone radical changes. Prior to the advent of gold ETPs, many investors interested in gaining exposure to gold had to rely on gold mining stocks. Gold ETPs have made it easier for investors to gain direct exposure to the gold price, removing the need to own gold miners in order to get exposure to gold price moves. From its peak in 2010, the gold mining sector has lost approximately US$125bn in market capitalization; over the same period gold ETP holdings have increased by US$45bn (Figure 9). The two are not necessarily directly linked, but anecdotal evidence indicates that some investors have chosen to get their gold exposure through ETPs rather than through gold miners.

The Benefits of Investing in Gold Miners

Despite the poor performance of gold miners’ shares over the past couple of years, investors should not disregard the potential benefits of investing in the mining sector. Over the past ten years, gold miners have tended to outperform the gold price during periods of rising global business activity, as measured by the US ISM Manufacturing index (Figure 2). In addition, in terms of portfolio allocation, an investor can potentially benefit from broader diversification and both gold and gold miners appear to have good diversification properties. The table below (Figure 10) shows how the risk-return profile of a portfolio has been improved by adding gold and gold miners’ shares to an allocation of bonds and equities. Although gold has offered the best opportunities in terms of improving the risk-return profile, a basket of mining stocks can also aid diversification of a traditional bond and equity portfolio (Figure 11).

An investor that substituted 10% of his equity and bond exposure with the returns of the DAXglobal® Gold Miners Index would have potentially increased his portfolio returns by 0.7 percentage point p.a. and decreased the riskiness of the portfolio by almost 4 percentage points. This portfolio would therefore have provided a higher Sharpe ratio compared to a more traditional allocation. However, a portfolio allocating 10% of its total exposure to gold would have had the best Sharpe ratio, as gold’s low correlation with other asset classes allowed it to substantially improve the risk-return profile of the portfolio.

Yield investors looking for income might also find gold mining stocks increasingly attractive. Although dividend yields in the gold mining industry have traditionally been low compared to other sectors, some companies are now distributing bigger dividends (Figure 12). Over the past six months, average dividends distributed by gold miners have more than doubled to over 1.5%. This trend is likely to continue as scarcity of profitable projects is increasingly forcing companies’ management to reward investors via higher dividends.


Gold miners’ shares have historically tended to be strongly correlated with the gold price, but this trend has declined in recent years. While the business fundamentals of miners as measured by margins and cash costs appear robust, a closer inspection of exploration and capital expenditures reveals a completely different picture. Lack of new discoveries, coupled with extinguishing brown-fields, has left mining companies with a production gap and cost that has undermined their performance. The introduction of gold ETPs has also provided investors with a more direct alternative to gaining exposure to gold price moves. However, mining companies have become increasingly aware of the lack of transparency and overbudget projects in the industry and are undertaking some drastic changes to reverse the current de-rating to the gold price. Gold miners have historically tended to outperform gold during periods of rising global growth and their valuations have now dropped from a substantial premium, to a discount to broad mining sector valuations, indicating likely limited scope for further de-rating. In addition, for investors that want yield, gold miners are starting to increase their dividend payments. With China and the US showing signs of economic recovery and equities back in favour, there may be scope for miners to begin to claw back some of their performance gap to gold.