Gold shares would soon play catch up

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In a recent research note, BCA Research argues that it is too soon to give up on gold shares – a sector that has underperformed gold bullion and liquidity plays over the past few years.

The report says: “Gold miner profits track gold prices and this has not changed in the past few years, although the tracking is far from perfect. What has changed is the traditional 2:1 relationship between changes in gold shares and underlying prices. Global gold shares are flat year-on-year in dollar terms, yet the dollar price of gold is up 22%. This is despite the fact that gold company hedge books are leaner than they have been in years.

“One possible explanation is that commodity-sensitive currencies have been strong in recent years. This places a wedge between revenues and costs for many gold producers. Put another way, gold in C$, A$ and SA rand terms has been weaker than in U.S. dollar terms. However, that has not been the case in recent months as the commodity currencies have dropped in the face of investor risk aversion.

“A more likely explanation relates to the ETF phenomenon. Gold company multiple compression accelerated as ETF holdings hit successive new highs in 2010 and 2011.

“While the divergence is unsustainable, it is difficult to tell when it will end. Even if gold shares are in a bear market versus gold prices, they are stretched relative to the downtrend in place since 2006. Perhaps global reflation and a softer dollar will spur a “broadening” of interest in lagging liquidity plays, such as gold shares.”

I am in agreement with BCA’s recommendation that one should continue to hold strategic positions in both gold and gold shares.

Source: BCA – Daily Insights Service, December 8, 2011.

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