Could Certain Commodities ETFs Yield a Potential Gold Mine For Investors

Feb 19 2014, 12:27pm CST | by

2013 marked the worst year for gold since 1981. It was the first negative year in 12 years, down -27%. This was mainly attributed to a lack of inflationary pressures and a booming developed equity market. Huge outflows were seen in gold funds and gold ETFs. The largest gold ETF, SPDR Gold Shares (GLD), lost over one third of its assets under management. Gold mining ETFs fared even worse, as Market Vectors Gold Miners ETF (GDX) fell over -54% in 2013, marking the third consecutive year of losses. Junior miners (GDXJ) were down over -60% in 2013.  With gold prices way down, is it finally time to buy back into precious metals?

Gold as a Hedge
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Markets got off to a rough start in January and that spilled into early February with the VIX spiking. The 10 year treasury yield fell to almost 2.6%, despite a general consensus of continuing rising rates. Equities typically start the year off strong due to the “January Effect” – a period when most investors rebalance portfolios – yet the S&P 500 lost -3.5% in the first month of the year. The Market Vectors Gold Miners ETF (GDX) exhibits a correlation coefficient of just 0.19 to the S&P 500 and as markets corrected in January, GDX gained an impressive 11%. While markets have rebounded somewhat in February, heightened volatility still exists. Having a low correlation to the market is what you want in an environment that is prone to big market swings.

Global Gold

The rising rate outlook in the US has been deemed a headwind for gold markets. However, if real wages grow in line with rising rates, demand for gold could increase as well. A study conducted by WGC’s “Gold Investor” report showed that gold returned 60% from October 2003 to October 2006 as US real interest rates rose from -1% to 3%. On an international scale, US demand for gold only accounts for less than ¼ of total global aggregate demand.  While the US may be entering a phase of tighter monetary policy, the majority of notable world governments are still currently engaged in a period of increased spending, borrowing, and monetary printing, all of which present tailwinds for the global gold market.

Focus on the Mines

Gold mining stocks are some of the cheapest equities currently available to investors. The below figure shows that gold producing companies are currently trading much lower than their historical average P/NAV multiples. 2013’s major selloff in gold mining stocks brought a wider valuation gap between physical gold and gold mining share prices. Comparing the miner focused Philadelphia Gold and Silver Index to the spot price of gold shows a current ratio of about .075 (current index at 98, spot price at $1,300). In the past 30 years, the ratio was typically above 0.2, suggesting that the mining index is currently undervalued.

Mining stocks offer exposure to gold with reduced exposure to fluctuations in gold prices as a company’s structure can give it the ability to absorb price changes. Gold prices do not necessarily need to appreciate to drive returns in mining stocks, rather a stabilizing gold price can generate results through decreased fixed mining costs. Barrick Gold Corp (ABX) is GDX’s top holding with an allocation of over 13%. As gold prices corrected in 2013, companies like ABX shifted their business models to focus on cutting costs in order to drive profits. Barrick Gold took action in 2013 selling multiple mines in Western Australia as well as selling its energy arm, which brought in $3B in a share sale to help cut debt.

Takeaway

Gold, and more specifically gold mining stocks, were oversold in 2013. US inflationary pressures may not be as influential, yet outlook for the global gold market is positive through 2014. It is highly unlikely that equity markets will return remotely as much as last year, making diversification a strong theme for 2014. Buying into the gold mining sector right now is a very cheap way to hedge against upcoming market corrections while also adding strong real asset diversification to your portfolio.

Source: Forbes Business

 
 

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