While mining companies have underperformed bullion, the exploration companies, developers, and junior mining companies have fared even worse. Investors in these companies are not really investing in exposure to the gold price at all but are betting on the chance of an economic discovery or significant mine expansion. While there are certainly some exceptions, these are the companies that Mark Twain was referring to when he said "A gold mine is a hole in the ground with a liar standing next to it."
There are good reasons to believe that gold stocks will continue to underperform the metal itself:
- First, the popularity of gold exchange-traded funds (now with some 80 million ounces in gold holdings worldwide, up from virtually nothing five years ago) has attracted funds that might have previously gone into the mining stocks. I expect the ETFs will continue to successfully compete with and continue to attract investor capital that might, in earlier years, have gone into the shares.
- Second, much of the growth in gold investment has occurred in China, India and other countries where there is no popular tradition or experience with gold-mining equity investments. This has further skewed – and will continue to skew – demand in favor of physical gold.
- Third, reserve depletion – the existing mining companies are running out of gold reserves or are only able to replace mined-out reserves with new reserves that are at greater depth, are more challenging geographically or metallurgically, and are therefore much more expensive to mine and refine.
- Fourth, many gold-oriented investors do not think highly of many mining-company managements and do not want the additional risks (see above) threatening gold-mining shares.
Despite the popularity of gold ETFs, it is important for investors to understand that they do not serve as an alternative to physical investment and ownership of the actual metal.
Investing in an ETF is not the same thing as owning the physical metal. With ETFs you do not actually own the physical metal and unless you are a large institutional investor you cannot take delivery of the physical metal.
Moreover, if it is important to you, gold exchange-traded funds do not provide the anonymity that accompanies purchase and ownership of physical bullion bars and coins.
In addition, there are risks inherent in ETF ownership that are not shared by bullion bars and coins held under your personal control. For one thing, as equities traded on public stock exchanges, ETFs are subject to exchange risk and their liquidity is dependent on the exchange operating without interruption. For another, ETFs are dependent on transfer agents, depositories, and custodians all functioning honestly and as expected.