In an environment of ballooning sovereign debts and major central banks expanding their balance sheets aggressively, real assets, such as gold, should increase in value.
Over the last few years, the physical price of gold has risen steadily, outperforming the S&P Metals & Mining Select Industry Index which tracks the world’s leading gold companies.
The divergence of gold price and gold mining share prices is an example of a market dislocation. Historically, the two move tightly together. The logic is simple: When gold price rises, the mining companies sell their gold for higher prices, and increase therefore there bottom line.
The two main reasons for this performance bridge are the following:
- Through the invention of Exchange Traded Funds, investments have been drawing away from gold equities. These funds, allow investors to own gold without having to worry about storage, insurance, transportation, purity, reselling…Gold ETF’s have grown significantly in size and are now a big player in commodity investing.
- The mining shares have additional risks related to production costs, geopolitical risks, fraud and corruption, resource nationalism, infrastructure access…A decade ago the average cost of extracting an ounce of gold from the ground stood at USD 200. Nowadays replacing depleted reserves is becoming harder. For instance, Barrick Gold’s extraction cost went up from USD 440/oz to 505 USD/oz in 2011 and this trend is likely to continue.
However, as more investors move towards gold as an investment, people will look for new ways to be long gold without actually holding gold bullion or buying an ETF like SPDR Gold Shares.
One way to bridge this performance gap is throughout dividends. Due to higher cash flows that these miners are generating, they have greatly increased their dividend payouts. Some miners have become even more creative and linked their dividends to the gold price itself, and I believe that these attractive dividend schemes could help persuade some investors into the miners instead of into gold. Such changes to dividend policy could mark a paradigm shift in the industry!
To conclude, mining companies have had to be more creative to differentiate themselves from other investment vehicles. But would that be sufficient?