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Gold Miners vs. The
S&P500 - Surprising Conclusions
Louis James, Chief Metals & Mining Investment
Strategist
We often hear the claim that gold producers have not met investors'
expectations for the past couple years. While there are many potential
reasons for this, one explanation for their underperformance lies in the
fact that producers diluted their share structures, leaving shareholders
with smaller gains than they would have otherwise harvested.
To show how this dilution has impacted the industry, let's first review how
gold miners performed last year compared to the S&P500.
The chart is hardly a surprise: the precious-metals producers had a poor
showing, losing 26.6% in 2012 – something we think will reverse this year –
while stocks in the S&P500 delivered a solid 14.2% annual gain.
We think that while last year's performance of the S&P500 companies is
commendable, the future may disappoint investors who believe the US economic
recovery is on solid footing: last week's GDP data suggest that our economy
continues to struggle, something that was immediately reflected in the price
of gold the day the news was released. As 2013 progresses, we expect to see
more signs of a weaker economy and subsequently, stronger gold prices.
But let's look at the bigger picture to see how the S&P500 has expanded
as a group during the past decade. To measure the rate of expansion, we
plotted the total market capitalization against growth of shares
outstanding. The idea here is to compare the rate of S&P 500 share
dilution to the change in size of the companies. Size does not equal
performance (we'll look at that in a moment), but it gives a rough idea
about how much market value investors may have gained had there been no
dilution at all.
[Technical note: We did not include all S&P 500 companies in the above
chart – only those for which share structure data was available since the
first quarter of 2003. For example, Google went public in 2004 and was not
included. We followed the same method with the HUI Index, with the only
stock excluded being New Gold Inc. (T.NGD).]
Since there is little growth in shares outstanding, the majority of the
market capitalization (Mcap) growth can be attributed to share price
performance.
The total Mcap of the S&P500 increased by 78.6%, or about 6% per year on
a compounded basis. And no wonder – the sector includes a lot of large
stocks that do not grow at the same rate as mining juniors. However, the
chart also shows how quickly market value can shrink when a crisis hits.
Let's now have a look at what happened to the HUI constituents within the
same time frame.
There are two observations to be made from these charts. First, compared to
S&P 500 companies, gold producers grossly overissued new shares. Since
2003, as a group, they more than doubled their shares outstanding,
significantly diluting existing investors.
Second, despite the large increase in shares outstanding, HUI companies have
grown their market capitalization by 302.5% as of the fourth quarter of
2012, quadrupling the size of the group. This comes in stark contrast to the
78.6% growth of the S&P500. On a compounded annual basis, gold companies
grew at 14.9% annually for the last ten years, more than twice as fast as
the S&P500.
So while shares outstanding of the gold miners were increasing at a high
rate, the market capitalization of the HUI constituents outpaced the growth
of shares outstanding, because the assets miners purchased with the funds
they received from the new shares generated extra value. Since market
capitalization doesn't necessarily expand when new shares are issued, it's
the price performance that accounts for this growth.
Looking at the next chart, you can see that the performance of gold stocks
continues to be both stronger and more volatile than the S&P 500. Note
that we didn't modify the indexes here – these are the performance numbers
that investors have been looking at for the past decade, and they make the
case that the gold-mining sector has been far from lackluster.
The gold-mining sector has been outperforming the S&P 500 for the vast
majority of the last decade.
With this focus on efficiency and economics, gold companies should richly
reward those bold enough to invest in them now. But there’s another way to
play the gold market that doesn’t involve buying producers, nor does it
require buying the yellow metal itself. And
it could be even more profitable...
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