Gold Up, Gold Stocks Down – Why?

by JDH on March 17, 2012

Let us pause during this beautiful late winter period (where in my corner of Ontario the temperature has bumped up against 20 degrees Celsius, which is great) and return to the eternal question: why is gold going up, and gold stocks are going down?  To the charts, batman:

Here’s gold, over the last two years:

Gold bullion has increased from $1,100 to $1,660, a gain of just over 50%. And yet, over the same two year period, here’s the AMEX Gold Bugs Index, the HUI, comprised of a basket of gold stocks:

As you can easily see, over the last two years the HUI has increased from 424 to 476, a gain of just over 12%.

How is it possible that the product gold miners produce can increase by 50%, but the producers themselves are only up by 12%?

One explanation is that producers have expenses to get the gold out of the ground, and as those expenses increase, their profit decreases.

What expenses do miners have? Fuel is a big one, to power the excavating trucks and blast furnaces.  If fuel costs are increasing, profitability won’t rise as fast as the price of gold.  Back to the charts:

Here’s Brent Crude Oil over the last two years:

No surprises here; the price of oil is up from $80 to $125 over the last two years, or about 45%.  So, it’s possible that increasing fuel costs have contributed to the suppression of gold stock prices.  However, here’s a chart of Brent Crude Oil, but instead of pricing it in dollars, it’s priced in ounces of gold:

Interestingly, as shown by the St. Patrick’s Day green line, the price of crude oil today is about the same as it was two years ago, when priced in terms of gold.

Stated another way, if you go to the gas pumps and pay for your gas with gold coins, it costs about the same today as it cost two years ago.  Gold has indeed preserved your wealth, because unlike paper dollars, you can buy the same amount of oil today as you could two years ago.

Does that mean I am therefore concluding that gold share prices are low because of high fuel costs?

Nope.  It may be a partial explanation, but that’s only a small part of the story.

Year to date the S&P 500 is up 11.65%, while oil year to date is up 8.45%.  Fuel costs are a component in most industries.  Airlines obviously depend on it, but any industry that produces a product, or consumes or ships a product, is influenced by the price of oil.  AAPL – Apple Inc. ships every iPad from China; it doesn’t appear that the higher cost of shipping has dented their stock price.  Ditto for every other industry.  And yes, I realize that fuel costs in a tiny iPhone are much less than the fuel costs to mine and refine gold, but if high fuel costs explained everything, every stock should be down, and in fact the exact opposite is happening.

(As an aside, I happened to be in my local Best Buy store at noon on Friday, the day the new iPad was released.  I asked the salesman if they had any, and he said “sure, over there, we’ve got lots”.  I asked if there was a mad rush, and he said they had a few people lined up in the morning, but there was no mad crush, and anyone who showed up at noon could buy as many as they wanted, with no line up.  That tells me that the stories like the one about Apple co-founder Steve Wozniak standing in line all night to buy the New iPad are just silly media creations.  No sane person waits all night to buy something they can get the next morning.  Here’s a tip: probably time to think about shorting Apple.  But I digress).

So why are gold stocks not tracking gold?  What happened to the leverage gold stocks should have compared to gold?  Here are a few more explanations, as I detailed last year in my post on Gold Bullion Up – Gold Stocks Flat – Why The Divergence?

  1. Hedge funds buy gold and short the mining stocks as a hedge;
  2. Fuel costs (as we just discussed)
  3. Gold is priced in U.S. dollars, but mining companies are in other places, like Canada, so currency fluctuations explain some of the difference
  4. These are short term anomalies, and will revert to normal over time
  5. The markets are manipulated.

Hmmmmmmmmm – markets manipulated; is that even possible??????

Yeah, it’s possible.  It’s possible that the boys with the printing presses don’t want to make it obvious that they are running the printing presses, so they keep a lid on the paper price of gold, but they also keep a lid on the price of paper mining shares.  Given that the entire gold mining sector isn’t that large (certainly nowhere near as large as the trillions in phony money being printed), shorting stocks to depress prices isn’t difficult.

(Feel free to read Ranting Andy’s thoughts on why it is that the markets get hit at certain times of the day, almost every day).

So what are the implications for investors?

I suspect that until the lid is blown of this thing share prices will remain depressed.  I have no idea how long the suppression will last, but since it’s existed for at least two years, a few more months, or even years, is possible.  That’s why I’m 50% in cash now, and it would appear wise to continue buying physical on dips.

Those are my thoughts. Feel free to comment below or over on the Buy High Sell Higher Forum.  Thanks for reading; see you next week.


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