Have Gold Equities lost their shine?

Historically gold equities have exhibited strong positive correlation with the gold price. However over the past few years a disconnect has become apparent, with many gold equities falling off a cliff.

Now to try and understand whether this gap will converge or continue to diverge we need to try and work out what has driven the gold price and what has issues have faced the gold miners.


Physical gold has always been seen as a safe haven asset and investors have moved to it in times of economic and political uncertainty. As a 'real' asset it is also seen as a store of value and an inflation hedge. Since the credit crunch we have witnessed extreme economic and political pressures and uncertainty, coupled with tremendous quantitative easing; almost the 'perfect storm' for gold, and as such the price rose dramatically from 2009-2011. 

Around 60% of gold demand is for jewellery, and much of this is from China and India. As these nations continue to develop it has further boosted demand for the precious metal and helped inflate the price.

With the price of gold double where it was 4 years ago, one would assume gold miners would be re-rated upwards, as revenues sore. However, we have not witnessed this. Whilst prices have risen costs have also risen. There has been steep wage and machinery inflation which has bitten into margins. Energy costs (which equate to around 50% of overall costs) have risen as the oil price remains stubbornly high. Mis management of gold miners has also been apparent as companies have seeked to grow production, regardless of margins and costs, and also embarked on poor Capex; Barrick's South American mining development came in around 60% (or $4bn) over budget! Greedy governments, seeing the high gold price, have slapped high royalties on the mines and so companies are forced to pay huge government taxation. All this has meant companies cannot return cash to shareholders and left investors with a bad taste in their mouths.

So what will bring investors back to gold equities? Well firstly they need to trust management again. Many CEOs in huge gold companies have been fired, replaced with management teams that are investor focussed - surely a good sign. This should lead to a curb on poor Capex spending and a focus on reducing production costs.

We have also seen reform from the world gold council on cost reporting. This extra transparency should hopefully lead to better understanding of all costs and highlight that super profits may not exist, which could lead to lower government taxations.

Gold miners should also look to pay more dividends. As investors, we now have the opportunity to purchase gold ETFs to gain exposure to the precious metal; gold companies can distinguish themselves from these ETFs by paying dividends.

Whilst positive changes are taking place in the mining sector, we still need to see a stability in gold price and political situation in many 'gold' countries before I consider gold equities a strong buy. However, with valuations low and fears of inflation still apparent I would consider drip feeding into gold equity funds. Funds like Investec Global Gold offer exposure to mid tier gold miners that have the ability to grow production and are often subject to M&A. Definitely not for the faint hearted, but with the market pricing in a gold price of around $1,100 there's a possibility of strong returns over the long term!