Four reasons underperforming gold equities may be about to turn

Apr 26th, 2018 | By | Category: Commodities

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By Joe Foster, portfolio manager and strategist, VanEck.

Joe Foster, Portfolio Manager and Strategist, VanEck

Joe Foster, portfolio manager and strategist, VanEck.

Lack of investor interest and misguided cost concerns have been fuelling underperformance in gold equity for some time but perhaps the market is now reaching a turning point. Gold equities outperformed gold bullion in March, as the NYSE Arca Gold Miners Index gained 2.9%, while the MVIS Global Junior Gold Miners Index advanced 2.2%.

We are starting to see some reversals in the factors which have recently put investors off gold equities and there are perhaps signs that gold stocks are beginning to claw back the performance they lost relative to gold this year.

Gold responds poorly to rate rise hikes

There are several reasons for gold’s recent underperformance. Since the Fed began raising rates in December 2015, the gold market has shown weakness in the weeks ahead of each rate decision. This pattern was repeated once again in March, as the low for the month was $1,306 per ounce on March 21, the day the Fed announced its sixth 0.25% rate increase since it began raising rates. The next FOMC meeting is under a week away and, with many predicting that the FED will be more aggressive than anticipated and raise rates four times in 2018, gold could show further weakness.

A lack of interest in safe-haven investments

While stock market volatility has returned to markets this year, it has yet to reach worrying levels that might motivate investors to hedge their exposure. General investor apathy towards the miners has been evident for some time, with anecdotal evidence suggesting that institutional investor interest in precious metals was at levels last seen in the early 2000s, before gold’s bull market. However, should the Fed begin to raise rates more aggressively, investors may get nervous about how successfully it can marry policy to rising inflation expectations without the US economy taking a hit. Gold may once again emerge as the safe-haven of choice.

Gold stocks have yet to recover from the early February sell-off

Investors viewed the general market sell-off as an overdue correction, rather than the re-emergence of systemic risks. This interpretation precluded a flight to safe-havens, causing gold and especially gold stocks to sell-off with the market in early February. As a result, gold producers are trading at a roughly 20% discount to their historic valuations. So far, the general sell-off has been too short to benefit safe havens. According to recent research, it usually takes a month or so of equity drawdown for gold to start to act like a hedge.

Markets are worried that a new cycle of mining cost inflation has begun

Several companies have suggested that mining costs will be higher in 2018, rising to around $925 per ounce from current levels of around $900. This represents an unwelcome increase, as mining costs have fallen roughly 25% to around the $900 per ounce level since 2012. However, based on company guidance so far, we believe these concerns are somewhat overblown and that costs will fluctuate around the $900 level for the foreseeable future. There are several reasons for this, namely that many companies have long-term contracts for materials and consumables and some have hedged fuel and currencies at low levels. Concerns over rising costs, therefore, should not put off investors. Under the right conditions, it probably won’t take long for the global gold mining sector to fill the valuation gap and regain its historic beta to gold.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)

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