Gold investors have struggled to keep up with the market over the last five years. In that period, the S&P 500 has risen by nearly 69% compared to nearly 46% for the pure-play gold investors index, the NYSE Arca Gold Miners Index.
Gold investors have shown particular weakness in recent months, falling at a much steeper rate than the rest of the market. For investors, the question is, is it time to sell gold stocks?
On the face of it, the answer is an easy one: yes. However, long-term trends suggest otherwise.
The Capital Cycle
Gold investors are driven by the capital cycle. The capital cycle is a phenomenon in which companies operating in industries where the suppliers do not control the price, and are simply price takers instead of price setters, increase their capital expenditure, and production, and raise more capital (in the form of debt and equity), in response to a rise in the price of the commodity they sell.
When the supply of that commodity becomes excessive, the price crashes, suppliers are left with lots of debt, and some facing bankruptcy. This triggers a period of deleveraging and scaling down of production. Production continues to decline until the excess supply is cleared and profitability returns to the market. Crucially, the share price performance tends to be inverse to asset growth: assets grow, and future stock performance declines. This is known as the “asset growth effect”.
Gold Investors are Poised to Outperform
Gold has followed a similar path. In the heady times when the price of gold shot up, gold investors increased their debt levels, issued more shares, and expanded production. Since the price collapsed with the bursting of the last great gold bubble, gold investors have been very disciplined, reducing their debt and capital expenditure. Even as the price has increased, gold investors have restrained themselves, showing greater capital discipline than in the past.
Although capital expenditure is set to increase in 2022, it remains well below the heights of the boom years. Indeed, not only are debt levels at a decade low, analysts worry that capital expenditure is not enough to meet demand. The effect of this is that the gold price has not been met with a corresponding increase in supply. The result is that gold investors will become more profitable.
Investors should note that the total returns to shareholders (TRS) are not just a function of share price appreciation, they are also derived from dividends. Gold investors have used their free cash flow to return cash to shareholders through dividends, and in many instances, gold investors have trailed the market on a share price basis but beaten it on a TRS basis.
So, this is not the time to sell gold stocks. Rather, this is a time to invest in gold stocks, as well as physical gold, the best gold IRA company, and gold exchange-traded funds (ETFs). This does not mean an indiscriminate investment policy on gold stocks.
Investors must be aware of the underlying economics of gold companies before investing in them. What this analysis shows, however, is that gold stocks are poised to outperform and that short-term declines should be seen as opportunities to buy gold stocks cheaply.