Gold or mining shares?

2012-DEC-15

There are many reasons to own physical gold. They arise from the financial and monetary uncertainty impacting investors around the globe. Some of the more obvious reasons are:

• Weakening economic activity and rising inflationary pressures bring back unpleasant memories of the stagflation experienced in the 1970s
• Geopolitical tensions remain a major area of focus
• The ongoing sovereign debt crisis and the knock-on effect it is having on the solvency of some of the world’s largest banks because they own too much government paper

By owning physical gold you are protected from the above because physical metal does not have counterparty risk. But do you also want to own the shares of gold mining companies? There are two things that need to be considered to answer this question.

The first is will the mining shares do well if gold appreciates? The answer is maybe. Normally the shares of gold mining companies appreciate at least as much as the price of gold, and sometimes do even better. But it does not always work out that way.

For example, from 2001-to-2011 gold has appreciated 14.5% per annum over these 11 years in terms of euros, and 17.7% per annum when gold’s price appreciation is measured in terms of US dollars. Over this same period, the Philadelphia Stock Exchange Gold and Silver Index, which in North America is a widely followed measure of gold mining companies, appreciated 3.2% per annum. Even when taking dividends into account, the mining shares over this period of time did not appreciate as much as the gold price.

Over the last 11 years, the shares of gold mining companies have on the whole done all right, and have in fact fared better than the general stock market. Clearly though, the shares have underperformed gold. The reason is that the shares of gold mining companies respond to circumstances differently than the price of gold, which leads to the second and more important point that needs to be considered.

The shares of gold mining companies are not a safe haven like physical gold. Gold does not have a balance sheet, management team, price/earnings ratio or any of the other things that characterise the shares of mining companies. This observation makes it clear that gold and mining shares are fundamentally different, meaning that the mining shares may not be suitable for everyone. Their risks need to be carefully studied, as is the case with any investment.