Gold miners will rally with rationality

Posted on: August 29, 2011 in: Canadian Equities, Commodities, Precious Metals with 0 comments

iShares CDN S&P/TSX Global Gold ( Ticker: XGD )


Last week, on a visit to Chicago’s Art Institute, I was reminded of the timeless allure of gold. Ancient Egyptian artifacts; Aztec burial masks, medieval European goblets; in each the recurring element was gold. Around the world, throughout human history, people have valued this untarnished metal.

When gold futures hit an all time high of $1,913 an ounce last Tuesday, it seemed our modern civilization was no different from the ancients in its love affair. Yet I cannot accept this. The rational side of my brain does the math and is baffled by its incredibly fast ascent.

There was a time when gold truly was the only store of wealth. Indian (and many other) brides would receive golden bangles to carry them through the lean times. But my Indian-born wife, though her name means “golden”, brought something more valuable: an education worth much more than any dowry. Could it be other Indian grooms – all those smart IIT engineers – are doing the same math as me?

There is some logic to gold’s recent rise. As the United States and Europe boost money supply in their efforts to keep their economies afloat, their currencies have fallen relative to gold. Exchange-traded funds holding gold bullion allow investors cheap, easy access to the metal; As a result they are hoarding about 2,200 tonnes of gold, more than most central banks.

But at some point, those holding gold – both the bride selling one of her bangles and the portfolio manager taking profit on her 5% allocation – will do the same math: what a little expensive gold can buy – a new flat-screen TV or relatively cheap gold producer stocks – offers better value than the gold itself.

Speaking of gold producers, while the SPDR Gold ETF (GLD-NY) is up 30% this year to date, iShares S&P/TSX Global Gold producers ETF (XGD-T) is up only 7%. This disparity not caused by currency moves. The loonie is at roughly the same value versus the U.S. dollar as it was at the start of the year.

The spread between miners and gold has rarely been as wide as it is now. Relative to the price per share of a couple of large producers of mainly gold – Barrick (ABX-T) and Goldcorp (G-T) – one ounce of gold at about $1750 is worth about 35 shares of either miner.

The last time this ratio was so high was in March 2009 when equity markets were caught in the final throes of a savage bear market. Before that, the ratio was high in October 2008, when Lehman collapsed and every doomsdayers rushed to buy gold.

Both times, after widening to extreme levels, the spread narrowed quickly, with gold dropping and miners’ share prices rising. We saw the beginning of this squeeze last week. After hitting at over 35 times early last week, gold prices fell sharply by Thursday, bringing the ratio down to about 33.9.

At archerETF, we expect this trend to continue until the spread returns to a more stable level in the mid-20’s. Apart from a fall in gold prices, we expect to see some strength in miners’ share prices. Miners have been selling their product at record profits for most of this year, as their financials will eventually reveal.

We may also see miners’ taking some action to boost their share prices, whether it be through increasing their dividends or buying back shares. Goldcorp, Newmont and Yamana have all raised their dividends substantially this year.

To invest in global gold producers, XGD is a good choice. Since I wrote about XGD last December, it has added more international firms to the mix. It used to hold 53 gold miners with about 70% of its allocation within Canada, another 15% in South Africa and the balance in the United States. XGD now holds 64 companies, with a much more diversified mix. Canadian firms still represent 57%, then the United States with 16% and South Africa with 11%. But now, Brazil, other African nations, Mexico (those Aztecs!), and Turkey are also included.

Disclosure: We may hold positions in any and all securities mentioned in this report.



archerETF Metrix XGD
Category Global Equity
Benchmark S&P TSX 60
Total Holdings 64
52 Week High $27.33
Recent Price $25.09
52 Week Low $22.06
Avg Daily Volume 0.73 Million Shrs
Avg Daily Volume ($) $18.26 Million
Total Market Cap $1.37 Billion
ETF Annual Fee 0.55%
ETF Trading Currency CAD
ETF FX Exposure 56% CAD/ 44% Other
Annual Volatility 43.6%
Correlation to S&P 500 43.1%
Return to Risk Ratio 0.63
Use of Leverage No
Use of Futures No
6 month Return 3.94%
1 Year Return 7.22%
2 Year Return 35.33%
3 Year Return 49.70%
Dividend Yield (TTM) 0.00%

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archerETF offers Global Tactical Portfolio Management.

Our outlook is Global: we invest across countries, sectors, commodities and other asset classes to improve returns. Our management is Tactical: we strive to select the right opportunities at the right times in response to changing market conditions to manage and minimize portfolio risk.

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© 2011 archerETF Portfolio Management is a division of Bellwether Investment Management, a discretionary portfolio manager registered with the Ontario Securities Commission. This report is provided for information only and does not constitute investment advice. While we believe the information to be accurate and timely, we make no claim or warranty to that effect. Please seek professional advice before making any investment decision. We may hold positions in any or all securities discussed in this report.

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