Rising 280% over the last eight years and resoundingly beating the S&P 500, gold has been embroiled in an epic bull market. The steady, sometimes ferocious, up move has reinvigorated gold bugs’ raison d’être, justified their eternal ravings about the coming paper money apocalypse, demonstrated to all the moral failings of buying equities, and morphed that weird uncle who socked away gold bars in his basement into the family’s version of Warren Buffett (check out Warren Buffett’s favorite stock picks).
But one player on ‘team gold’ has not quite achieved the acclaim of that uncle. One member, though performing admirably, has been forced to hold onto gold’s coattails with two fingers. We at Insider Monkey are talking about gold equities (see last year’s recap of this investment group).
In contrast to the rise in physical gold prices, gold stock indices have notably trailed in terms of performance over the same period. The blue-chip XAU gold stock index has risen only 72%. The HUI index, skewed toward smaller cap issues, has risen 112%. Sub-sectors like South African gold stocks, plagued by labor and political worries, missed the team bus entirely: AngloGold Ashanti Limited (NYSE:AU) has fallen 20% while Gold Fields Limited (NYSE:GFI) and Harmony Gold Mining Co. (NYSE:HMY) are flat. The relative underperformance of gold equities has been particularly severe the last two years as the price of bullion entered a consolidation phase and gold equities swooned.
Upon inspection, this result seems peculiar. Take for instance, the world’s largest player, Barrick Gold Corporation (NYSE:ABX). Barrick has impressively grown revenues and earnings the last six years, nearly tripling both. Hedges have been closed out and dividends increased. Yet, ABX shares, and gold equity prices in general, have not increased to the extent of what a gold bug would have imagined in the face of an eight-year, 280% rise in bullion prices. ABX shares have risen only 55% over the last eight years. The result has been a crushing of both ABX and the sector’s price-to-earnings ratios.
But as economic theory tells us, markets are forward-looking, discounting machines. What could the market be so severely discounting that ABX and gold stocks have, consequently, strongly trailed gold bullion’s performance? The answer lies in the cost of maintaining and growing gold production. From this perspective, the underperformance of the gold stock universe is understandable.
Why is this the case?