The Mystery of Gold vs. Gold Mining Company Performance
Over the last few years, gold mining stocks have lagged the performance of gold itself, a highly unusual
relationship. Historically the operating leverage inherent in gold mining companies has meant that their
share prices have tended to outperform gold bullion prices, when gold is rising in price. The chart below
shows that gold stock prices have advanced 50% over the last five years, but this is far below the gold
price advance of 150%. What are the likely reasons?
Source: Bloomberg. Data as of 8/15/11. Green line represents the price performance of gold bullion. Red line represents the performance of the
world’s largest gold mining corporations.
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A common explanation is that energy prices, whether for oil and electricity, have gone up
substantially and heavy equipment costs have escalated as well. We understand the argument but
the increases in these costs are not sufficient to explain why gold miners’ shares have lagged.
Even with substantial operating cost increases, a leading gold miner has seen EPS increase from
$1.75 in 2006 to $4.55 last year. Earnings per share in 2010 were 2.6X as large as they were five
years earlier. This mining company now pays an annual dividend about the same as the S&P 500
and its dividend has grown at a 10% rate over the last five years.
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ClearBridge Advisors is comprised of ClearBridge Advisors, LLC and ClearBridge Asset Management Inc.
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The “law of large numbers” may help explain why gold miners’ shares have lagged. Over the last
decade, the leading gold producers have reached annual production levels that may be difficult to
maintain. Some companies have reached annual production levels of between 6 and 8 million
ounces. There is a real question whether their pipelines of new projects or acquisition candidates
will permit current production levels to be maintained, let alone grow in the future. One recently
acted in a manner that suggests there may be some truth that the “law of large numbers” may be
catching up with it. Earlier this year that company made an acquisition of a large potential copper
producer, a purchase which suggests the company felt that maintaining or growing gold
production in the future would be challenging. Are gold miners, like pharmaceutical companies,
being penalized because new opportunities to increase gold production may be limited?
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In the 1970’s, oil prices rose substantially because of wars and uncertainty in the Middle East.
The higher prices prompted governments around the world to renegotiate agreements with oil
companies. Today 80% of all oil is owned by producing nations and national oil companies, a
dramatic change from 35 years ago.1 Today, gold increasingly is seen as money, a monetary
asset in an environment in which gold is seen as a hedge against currency devaluation, inflation
and political uncertainty. Why won’t one or more of the producing nations of the world decide
that gold deserves a place alongside oil and that current agreements should be modified in favor
of the producing nation? It appears that Peru may be considering new taxes on gold production in
that nation. Could this be a forerunner of similar efforts by other governments? Could this have
anything to do with the underperformance of gold shares?
We have long been positive on gold but the discrepancy between gold share prices and the metal itself is
troubling. When I entered the investment business more than four decades ago one of my mentors told
me that all non-confirmations ultimately are resolved on the downside. It will be interesting to see
whether this happens in the future or if gold stocks begin to do better relative to gold.
We believe that gold at current prices is an insurance policy, not a classical investment medium such as
stocks or bonds. Currently gold stocks seem to be a much better buy than bullion itself, but we again
refer to the caveats listed above. It appears that the leading economies in the world will need to adopt
policies to produce growth because the alternative is deflation and truly painful trade-offs where
entitlement rationalization is concerned. The monetary and fiscal programs contemplated in the United
States and Europe suggest approaches that lead to currency devaluation longer term, hence underpinning
the rationale for some gold in many investors’ portfolios. Depending on individual investor
considerations, we believe 5-10% gold positions are warranted.
1
Oil & Gas Journal, September 15, 2010
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ClearBridge Advisors is comprised of ClearBridge Advisors, LLC and ClearBridge Asset Management Inc.
We’re not sure how Humpy Dumpty (e.g. European Union) will be put back together again. We also
wonder whether the “adults” will show up in Washington D.C. any time soon. However, the recent sharp
price declines for high grade equities have changed the risk/reward between them and gold.
Notwithstanding the high level of uncertainties at this time, we believe higher quality common stocks,
including those with fortress balance sheets and multi-national business exposures, means that the upside
for them over the next 6-12 months probably is substantially better than for gold related investments.
Diversification away from the U.S. dollar almost certainly will involve purchases by sovereign wealth
funds of large publicly traded multi-national companies.
We suggest that investors use the current period of lower oil prices to consider energy companies
including those that are primarily producers of natural gas. The price for crude oil today is about 20X that
when compared to natural gas vs. a more normal 8:1 relationship. We regard natural gas as the “bridge
fuel” to the future. We believe many Basic Materials companies also are attractive at this time. For
investors with the ability and willingness to buy unpopular merchandise, we suggest Financials. We
believe the risk/reward vs. the overall market is compelling at this time.
John G. Goode
August 15, 2011
The information and views contained in this commentary are as of August 15, 2011 and are subject to change. It is for informational purposes
only and does not constitute, and should not be construed as, investment advice or recommendations with respect to the information or specific
securities presented. Forecasts are inherently limited and should not be relied upon as an indication of actual or future performance. All
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RP 87-0811
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ClearBridge Advisors is comprised of ClearBridge Advisors, LLC and ClearBridge Asset Management Inc.