It's something that has wrong-footed and infuriated me in recent years. And it's a theme that I, and many others like me, keep coming back to.
I'm talking about the relative underperformance of gold miners versus the metal.
That is, gold has risen, but the miners haven't.
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Why is this happening? And can we expect more of the same? Or will the tide finally turn in 2012?
Gold miners had a terrible 2011
The gold price started 2011 at $1,424 an ounce; it ended the year at $1,564. A typical - in the context of the last ten years - 10% annual rise.
The miners, on the other hand, haven't followed the script at all. The index of senior gold miners (the HUI), fell by 14% in 2011. The junior gold miners, as represented by the exchange-traded fund (ETF) GDXJ, fell 38%. And the gold explorers (GLDX) fell by nearly 50%.
Why has this happened? The theory is that if gold rises by 10%, gold miners should rise by even more: 15% to 20%, say. And the juniors and the lowly exploration companies should rise by still more, surely?
Yet with a few exceptions well-run companies, or those that have made big discoveries it hasn't been the case in recent years. Rather, gold stocks have only risen with gold if equity markets in general are rising too, or at least flat. If equities are tanking, as they did in 2011, gold stocks will too.
So why have the miners been so disappointing in recent years? Let's look back at previous crises and see if it casts any light on today.
Gold miners thrived in the 1930s
Two previous long-term economic contractions during which gold flourished include the 1930s and the 1970s. And in the 1930s, gold stocks did incredibly well too. Homestake, the leading US gold miner of the time, rose by some 600%. The company's big move came between 1932 and 1935 (from $2 to $6) but the Dow, too, was rising during this period. Homestake saw gentler gains between 1930 and 1932, a period when the Dow was falling.
But then, in 1933, it became illegal for Americans to own gold. Executive Order 6102, signed into existence on 5 April 1933, by US President Franklin D Roosevelt forbade the "hoarding of gold coin, gold b, and gold certificates within the continental United States" and required that citizens hand over their gold by 1 May.
So Homestake Mining and similar companies became one of the only ways Americans could buy gold, or at least an equivalent, and the stock benefited from this. On top of that, in 1934, the Gold Reserve Act saw gold revalued upwards from $20 to $35 an ounce. As a result, Homestake's profits ballooned.
These days, many people now blame gold ETFs for the failure of gold stocks to deliver. A majority of gold mining executives questioned for the 2012 Pricewaterhouse Coopers (PwC) Gold Price Report, said that while the high gold price was having a positive impact on their share price, it wasn't as significant as they'd have expected. Both the executives and gold analysts cited ETFs as the "main driver behind lagging share values".
You can see what they're getting at. ETFs such as GLD and PHAU have made it much easier to own gold. So they have attracted capital that might otherwise have gone into gold stocks. It means that gold investors don't have to take individual company risk or cope with the many problems that come with owning a gold stock: incompetent management, escalating costs, labour issues, geo-political issues, funding, stock dilution, geological or metallurgical difficulties. These ETFs now occupy the niche that Homestake enjoyed in the 1930s.
However, I don't entirely buy this complaint about ETFs. There are also ETFs that track the various gold mining sectors, so you don't ever have to take on individual company risk if you don't want to.
How did gold stocks do in the 1970s?
Below we see gold stocks in the 1970s, during gold's last bull market. This is the US Gold Index.
(Thanks, as always, to Nick Laird of Sharelynx.com for preparing the chart)
You can see that from 1973 to 1974, (at a time when the S&P 500 was falling), gold stocks rose. At that point, it was still illegal for Americans to own gold (that ended on 1 January 1975).
Gold stocks then went on to fall from mid-1975 to late 1978, before setting off on the mother of all bull market runs, which ended in 1980, along with gold's bull market. The S&P 500 was broadly flat during this period.
I certainly don't think the current bull market in gold is over just yet. In 1980 monetary policy suddenly became a lot tighter. We had interest rates over 15%. Paul Volcker was at the head of the Federal Reserve. We have no such fiscal discipline among central bankers today. And, interestingly, gold stocks - despite gold's fall - broke to new highs twice in the 1980s. So the gold mining sector should still have plenty of good times ahead of it.
What will it take to turn the gold miners around?
But what could get gold miners out of their current slump? The PwC report notes that the companies are trying to make themselves more attractive. Some are getting more creative with dividends - linking them to the gold price, paying out more frequently and, in some cases, actually paying in gold bullion.
That's good news. In a world simultaneously starved of cash, but awash with it, dividends are an attractive proposition. As I've long said, the strategy should be find the stuff, mine the stuff, make money, give it back to the shareholders. It's not rocket science. Companies that do that beat the market.
Plans to make acquisitions are also rising - 29% of respondents were planning to spend their cash on acquisitions this year. Perhaps we'll start to see the long-touted-but-never-realised frenzy of takeover and merger & acquisition activity in the junior sector. Here's hoping.
Obviously, certain strategies will suit some companies, but not others. It's up to management to make the right call. But company practice at all levels of the gold mining sector has to improve, otherwise they'll remain mired in 'dogsville'.
It is no longer enough to just be a gold company in a gold bull market there are plenty of other ways for investors to get access to gold now. The market is demanding something more. And investors should be looking to those companies where management is acknowledging this and trying to do something about it.
This article is taken from the free investment email Money Morning. Sign up to Money Morning here .
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