January 02, 2012

Special Report: A Major Divergence of Gold Asset Prices There is a major divergence currently in the price of different gold asset classes – bullion vs. miners vs. ETFs. This has been ongoing for several years and became especially severe in 2011. It is not within the scope of this paper to explain the reasons or rationale for the divergence. Yet, it is my belief the divergence will be corrected over time and it offers arbitrage and hedge traders a unique opportunity. Bullion The standard measure of Gold assets is the price of bullion itself, as shown below in various time frames and formats.

ETFs The charts below show the relationship between the price of spot Gold and the price of GLD (times 10) and the price of IAU (times 100). These chart shows that bullion has gained about $50 per ounce on the ETFs over the past eight years, partially due to the technical construction of the ETFs.

Miners Much more dramatic has been the gain by bullion over the miners. The following charts are shown: • • • • • • GDX – Market Vectors Gold Miners GDXJ – Junior miners Newmont Freemont McMoran Kinross Barrick

By the way, I do not accept the bullish argument for junior miners. Junior miners stock is a cheap man’s bullion play. If the economics are right for junior miners, how much better are they for low-cost miners?

Whereas the bull trend in bullion continued (in fact accelerated) through the August/September 2011 high, the miners topped in 2008. The divergence has become more pronounced since April 2011 as seen below in the comparison of GLD to the GDX and GDXJ (source: Vince Martin).

This divergence is counter historical. In fact, as shown by the table below (updated through 2010), an investment in the major miners has been a better investment than in bullion over the years when dividends are factored into the equation. The compounded annual ROR is based on the 1980s lows for the miners and the 1985 low for Silver and 1991 low for Gold in order to give the two metals an some comparative advantage.

I am sure that Gold bulls can give legitimate reasons why bullion is a better bet than miner stocks, some of the reasons dealing with the breakdown of the modern world as we know it or matters of taxation. Yet, I am willing to put my saddle on the miners’ horse. The graph below is the HUI/Gold ratio, calculated by dividing the Amex $HUI by spot bullion. The ratio topped early 2006.


Summary Gold bulls and those familiar with macro economics on these markets may have a much better knowledge on the relationship of bullion to miners, but in my opinion the divergence shows that the chase into bullion has been more on speculation than on fundamentals. It would seem to me that the real value of Gold is in the ability to own the ground it comes from and the profits to produce the underlying asset, not in the underlying asset itself. I am sure there are factors that make this conclusion much more simplified than I have presented, but it is my take. Bullion is overpriced. Speculators should short bullion or GLD and buy the stock of miners in approximately equal dollar amounts. ###

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