Extracting value is suddenly hard

SEP 30, 2012
By  JKEPHART
Precious-metals-mining companies broke out of a yearlong stock slump last month, but questions persist about whether investors are better off avoiding these middlemen and buying the commodities themselves. Mining operations historically have been a backdoor way for investors to benefit from the rising price of precious metals such as gold and silver. In theory, rising commodities prices should translate into greater earnings and free cash flow for miners. The reality has been different for the better part of this year, though. The $8.66 billion Market Vectors Gold Miners ETF (GDX) was down 7% through last month. The $2.6 billion Market Vectors Junior Gold Miners ETF (GDXJ), which focuses on small and midsize companies involved in the early stages of gold exploration and production, was down 12%. The price of gold, as measured by the $68 billion SPDR Gold Shares ETF (GLD), was up 8% over the same period. The same disconnect can be seen in silver. The performance of the physical shares via the $9.4 billion iShares Silver Trust ETF (SLV) was up almost 15%, while the $300 million Global X Silver Miners ETF (SIL) was up just 1.54% “It's not what you expect to see,” said Dan Denbow, portfolio manager of the $2 billion USAA Precious Metals and Minerals Fund (USAGX). The underperformance results from the rising cost of production and political issues in some of the bigger mining countries, he said. “It all added extra risk for investors. For most, it was easier to just invest directly in the metals,” Mr. Denbow said. As access to the physical metals has become easier for investors, demand for mining company stocks has decreased, said Will Rhind, managing director of ETF Securities LLC.

"SECULAR SHIFT'

What's more, demand may never come back. “There's been a secular shift,” Mr. Rhind said. “Before 2003 [when the first physical-gold exchange-traded fund was launched], you had to buy a mining company to get exposure to gold. Now there's a way to get exposure to the gold price without taking on any company risks,” Mr. Rhind said. “We've seen $125 billion go into physical gold ETFs since 2003,” he said. “The demand has come at the expense of the mining companies.” The lack of interest in miners finally turned into opportunity last month for Lewis Altfest, chief investment officer at Altfest Personal Wealth Management. “The disparity between gold prices and the mining companies is fairly wide now,” he said. “That makes the gold stocks reasonable.” The market seems to agree with Mr. Altfest at the moment. Last month, gold-mining stocks rallied to a 12% gain, twice that of gold. Likewise, the share price for silver miners rose 17%, versus 14% for the metal. Mr. Denbow expects the mining stocks to move increasingly in line with the underlying metals as the industry focuses more on the most lucrative projects and cuts back on less profitable ventures. That isn't the only selling point for mining companies. With gold near $1,700 an ounce, some outfits have started returning capital to investors through dividends — a first, according to Mr. Denbow. It is equally important to remember that mining companies' operating leverage works both ways. If the price of gold or silver starts to crumble, earnings and free cash flow are likely to fall much more quickly than the price of the metals. Moreover, mining stocks don't have some of the diversification benefits of the physical shares. “They're stocks,” Mr. Rhind said. “By definition, they're going to be more correlated to the equity market than the metals.” [email protected] Twitter: @jasonkephart

Latest News

SEC charges Chicago-based investment adviser with overbilling clients more than $2.5M in fees
SEC charges Chicago-based investment adviser with overbilling clients more than $2.5M in fees

Eliseo Prisno, a former Merrill advisor, allegedly collected unapproved fees from Filipino clients by secretly accessing their accounts at two separate brokerages.

Apella Wealth comes to Washington with Independence Wealth Advisors
Apella Wealth comes to Washington with Independence Wealth Advisors

The Harford, Connecticut-based RIA is expanding into a new market in the mid-Atlantic region while crossing another billion-dollar milestone.

Citi's Sieg sees rich clients pivoting from US to UK
Citi's Sieg sees rich clients pivoting from US to UK

The Wall Street giant's global wealth head says affluent clients are shifting away from America amid growing fallout from President Donald Trump's hardline politics.

US employment report reactions: Overall better than expected, but concerns with underlying data
US employment report reactions: Overall better than expected, but concerns with underlying data

Chief economists, advisors, and chief investment officers share their reactions to the June US employment report.

Creative Planning's Peter Mallouk slams 'offensive' congressional stock trading
Creative Planning's Peter Mallouk slams 'offensive' congressional stock trading

"This shouldn’t be hard to ban, but neither party will do it. So offensive to the people they serve," RIA titan Peter Mallouk said in a post that referenced Nancy Pelosi's reported stock gains.

SPONSORED How advisors can build for high-net-worth complexity

Orion's Tom Wilson on delivering coordinated, high-touch service in a world where returns alone no longer set you apart.

SPONSORED RILAs bring stability, growth during volatile markets

Barely a decade old, registered index-linked annuities have quickly surged in popularity, thanks to their unique blend of protection and growth potential—an appealing option for investors looking to chart a steadier course through today's choppy market waters, says Myles Lambert, Brighthouse Financial.