Thursday, June 24, 2010

Graham Summers - Will Gold Miners Act Like Stocks or Gold During the Crash?

Graham writes newsletters for his company, Phoenix Capital Research. I have followed Graham’s writing for quite some time and have found his knowledge to be both deep and consistent. He is not a “willow in the wind” when it comes to understanding the predicament of our economy and of our debt based monetary system.

He writes a daily newsletter that he provides for free, called Gains Pains & Capital, you can sign up at his site here, there is a sign up block in the upper left hand corner: Gains Pains & Capital. Of course he does offer paid for services of which I have no personal experience and receive no compensation or any other consideration for sharing Graham’s work. I always recommend caution in paying for and following the investment advice of others.

For educational purposes, I have agreed to occasionally reprint some of his articles, I think you’ll find them insightful and you will surely pick up a nugget or two with every installment. In the following piece, Graham performed a small study of the relationship in performance between gold stocks and gold miners, especially during times of equity stress – I think you may find it interesting.

Will Gold Miners Act Like Stocks or Gold During the Crash?

With stocks collapsing and Gold rallying to new all-time highs in both US Dollars and the Euro, the key question for precious metals investors is:

Will gold miners act like stocks or Gold during the Crash?

Unfortunately, there is no simple answer; it all depends on how you look at it. Historically, when the going is good, miners act like Gold. However, when things get ugly, they tend to act like stocks.

Let me explain…

As you know, over the last ten years Gold has rallied roughly 340% from $250 to its all-time high of $1,242 yesterday. Over the same time period stocks, as measured by the S&P 500, have actually fallen some 27% in value. That’s a heck of a difference in performance.

When you add Gold miners to this mix (as measured by the HUI Gold Bugs index), you find that in the long-term, miners have not only acted like Gold, they’ve acted like Gold on steroids: since 2000, the HUI Index has rallied more than 500% compared to 340% for Gold bullion over the same time period.

So over a ten-year horizon, the answer is quite simple: miners follow Gold more than stocks. A chart plotting the three assets makes this clear:

However, very few investors only look at their portfolios every ten years. Most of us tend to look every week, if not every day. Which is why it’s important to note that anyone who invests in Gold mining companies expecting to mirror Gold’s performance needs to have an unbelievably strong stomach. Because when the going gets bad, miners have a tendency to mimic stocks.

The above chart (weekly) shows the performance of Gold vs. the S&P 500 vs. the HUI index during the 2008 Crash. As you can see, miners took it on the chin nearly as much as stocks during the collapse. In 2008, stocks fell 37%, Gold miners fell 30%, and Gold actually ROSE 5% (despite an extremely volatile year).

So the last time things got really ugly, Gold mining stocks acted more like stocks than Gold. However, if you could hold on through the gut-wrenching drops, mining stocks rebounded much more quickly than stocks (though not as quickly as Gold).

Personally, I doubt anyone has a pain threshold high enough to sit through a drop like that of Autumn 2008 without panicking and selling. However, those who did stomach the drop quickly saw their mining shares rise along with Gold, and start outperforming stocks handily.

Which brings us back to my original statement: historically, when the going is good, miners act like Gold. However, when things get ugly, they tend to act like stocks.

That is until today.

During this latest market rout started at the end of April 2010, the HUI index and Gold initially fell along with stocks. But then something odd happened: the HUI and Gold both stopped collapsing and actually began to rally while the S&P 500 continued to collapse:

Miners now appear at a crossroads. They have not yet totally decoupled from stocks, but are showing much greater relative strength compared to the S&P 500. In plain terms, we appear to be nearing a time in which mining stocks will trade almost entirely along with Gold rather than stocks. We’re not quite there yet, but it is approaching.

What does this mean? If a Crash were to hit right tomorrow, mining stocks would likely fall along with the S&P 500. However, they would fall less, rebound more quickly, and outperform the general market.

Will this always be the case? I cannot say. But if miners ever DO become totally decoupled from stocks, they’ll be a phenomenal investment. Remember, Gold only fell a mere 5% during this latest market rout. And it reclaimed ALL of its losses in roughly two weeks.

Meanwhile, stocks continue to dive.

Which asset do you want to own?

Good Investing!

Graham Summers