Gold Stocks are Cheap

What’s wrong with gold stocks?

For the last several months, they’ve been trading a lot like stocks…but nothing like gold. Such is the occasional curse of the gold stock investor. In some market phases, gold stock investors failed to “get paid,” even when gold is soaring.

One of your editor’s friends, a gold stock expert, used to joke, “Gold stocks are the most empathetic of all investments. They fall when the stock market is falling, and also fall when the gold price is falling.”

While not entirely true, this observation is not entirely false either. For long periods of time, gold stocks can produce far more frustration than satisfaction. The last three-and-a-half years illustrate the point. Since the day the gold price first jumped above $1,000 an ounce on March 13, 2008, the yellow metal has soared 83%. But over the same time frame, gold stocks, as represented by the Philadelphia Gold and Silver Index, have gained a meager 9%.

While it’s true that plus-9% is better than the minus-3% the S&P 500 Index has delivered since mid-March 2008, no investor buys a gold stock to make 9% while the gold price is soaring 83%.

Furthermore, there may never have been a more difficult “plus 9” in the history of financial markets. Between March 2008 and late October of the same year, the XAU Index plummeted 67%. An investor would have had to stay put during that entire, sickening decline — and resist the temptation to cut his losses during the ensuing rebound — in order to eke out his “plus 9.”

On paper, therefore, riding the bull market in gold during the last few years has been “easy money.” In the real world, it has been anything but. Gold and gold stocks both recovered throughout 2009. Even so, during most of the ensuing two years — from October 2009 to the present — owning gold stocks has remained an exercise in frustration.

On October 2, 2009, gold traded below $1,000 an ounce for the very last time (at least so far) and ended the New York trading session at $1,002.80. Since then, the gold price has soared 82%. But again, gold stocks have lagged far behind. Over the last few months, gold stocks have delivered even less glittering results. While gold is up 30%, the XAU Index has gone nowhere. Perhaps gold stocks are due for a change of fortune.

The Upward Price Trend of Gold vs. The Flat Price Trend of Gold Stocks

As the chart below illustrates, the XAU Index has spent most of the last 20 years selling for about 20% to 25% of the level of the gold price. During the depths of the 2008 crisis, the XAU plummeted to 11.1% of the gold price. This ratio subsequently rebounded somewhat, but has been rolling back over during the last few months and has almost returned to the crisis lows of 2008. At today’s quote, the XAU sells for 11.9% of the gold price.

XAU Gold and Silver Stock Index Relative to the Gold Price

In other words, gold stocks are very lowly priced, relative to gold. This looks like a buying opportunity, not simply because gold stocks are cheap relative to gold, but also because gold stocks are cheap from almost every fundamental perspective. (We will examine that theme more closely in tomorrow’s Daily Reckoning).

No “Absolute Law of Mean-Regression” can guarantee that gold stocks will begin outperforming gold itself. Furthermore, no absolute law of any kind can guarantee that outperformance would be synonymous with positive performance.

Thus, the only absolute law that pertains is this one: Cheap is better than expensive, all else being equal.

Gold stocks are cheap.

Eric Fry
for The Daily Reckoning