Gold Companies Need a Material Change in their Playbook

After years of chasing production growth at the expense of shareholder returns, energy producers finally found religion and redirected their bloated capital budgets towards bigger dividends and larger share buybacks. In return, the energy sector moved from being “uninvestible” by many to a core holding required for a portfolio. In fact, energy was the best performing sector last year.

Gold companies should follow the same playbook.

One exchange traded fund we looked up, which tracks the share prices of gold producers, began trading in May 2006 for $32.73 (after adjusting for dividends). At the very bottom of the Great Financial Crisis in March 2009, the security hit $29.47. Today, it sits at $29.40. In other words, a basket of gold producer stocks is just about unchanged (even after dividends) since the market bottom almost 14 years ago.

However, we don’t see any signs that the C-suite of the gold producers will follow the same playbook as the energy producers.

Many gold companies are frustrated with the lackluster performance of their stock prices. We’re hearing from our industry contacts within the space that many are looking to acquire copper assets. After all, copper will be needed as the electrification of vehicles rolls out. One electric vehicle uses almost four times as much copper as a typical combustion engine vehicle. However, most “goldbugs” want a pure play investment in gold – not copper.

But that’s not the only reason to avoid investing in gold companies.

Finding an alternative to a fiat currency no longer leads exclusively to gold. Cryptocurrencies – and there are several of them – have attracted the interests of speculators that once flocked to gold.

It’s hard to tell exactly what gold does. Every investor offers a different explanation for the metal’s actual function. Some say it’s insurance against risk (yet after surpassing US$1000 per ounce earlier in 2008, it dropped like a rock later that year when the U.S. banks imploded); others will argue it’s a hedge against inflation (though today’s US$1950 price is no different than where it was 3 years ago when we were all in lockdown). We’ve heard people say it does well as central banks print money since its supply increases while the total sum of gold bullion stays constant (however, since the U.S. Federal Reserve began expanding its Balance Sheet 15 years ago, the gold price has increased by an annualized +5%, underperforming the S&P 500’s +11% return since then).

Historically speaking, gold has a weak correlation to inflation. For those with the statistical curiosity, the correlation between gold and inflation has been a mere 0.16 over the last half century (0 indicates no relationship while 1 infers that the two move in unison). Gold performed well in the 1973-79 period of stagflation during the energy crisis yet produced negative returns during 1980-84 and 1988-91 when inflation was elevated.

In other words, gold does not react to the same events in a predictable and consistent way.

When we find out exactly what it is that gold does, we’ll let you know. Until then, we will steer clear of the sector.

-Jeff Pollock

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