ST. LOUIS (MineFund.com) -- Tekoa da Silva of Mining Stock Talk interviewed Tim Wood to discuss the article: “Stunningly True: Gold ETF Has Badly Damaged Gold Equities.”
Tekoa da Silva: Can you briefly share with our listeners the concept described in your recent article, "Stunningly True: Gold ETF Has Badly Damaged Gold Equities"?
Tim Wood: Simply stated, the article and accompanying chart show that gold equities have suffered reduced leverage to gold as the bullion price has gone higher, whilst the gold ETF has enjoyed higher leverage.
By leverage, I mean the market value of the securities relative to the price of gold. In this case it is a very simple ratio that divides indexed market values by an indexed gold price so that we are comparing apples with apples.
Obviously that caught my attention because we should expect both types of securities to enjoy increasing leverage. In fact, my expectation was always that gold stocks would outperform any physical or derivative product.
TS: When was it that you first discovered this negative correlativity?
TW: I had been puzzled for some time that gold stocks were dragging an anchor. By that I mean it was apparent that the leading gold equities were very lethargic in responding to higher prices. It became very apparent in this most recent run to $1,260 per ounce. Gold stocks were, literally, dead in the water. Some of them were actually taking on water and at this point we are actually back to levels near the worst of the credit crisis in 2008. The gold ETF has continued to gain leverage
It was more puzzling because this was not isolated to, say, hedged or unhedged gold stocks, or small vs large ones. As a rule of thumb, the whole sector, especially North American listed stocks, was showing progressively less gearing to the gold price.
I just happened to wonder what would happen if I compared the leverage of a group of very liquid and respected gold stocks against the ETF. And frankly, I was stunned by the results, and more stunned that there is evidence of moderate reciprocal relationship – when the ETF loses leverage, gold stocks gain leverage.
TS: My first thought in looking at this is, "What an unfortunate time to be a shareholder"...but would this trend suggest increased share buybacks...and a "low prices cure low prices" effect?
TW: I think the share buybacks are an interesting proposition. It actually points to part of the problem in that the companies are guilty of issuing too much of their own paper. They do it relentlessly and in big chunks, and the lack of leverage exacerbates the problem because they end up having to issue more and more just to keep pace.
That said, the reality is that the gold industry has very little cash on hand. If I compare gold stocks with tech stocks it is frightening to see how little cash the miners have and yet many have multi-billion dollar projects in the pipeline.
So share buybacks are probably not viable given the upcoming financing requirements.
We also have to be realistic about the disappointments that the industry has dished out. There are a lot of companies limping about because they’ve shot themselves in one or both feet thanks to bungled projects or failed promises.
Investors don’t like the risk associated with these failures and that is a lot of the reason why the money flow has gone to physical instead of equities.
TS: Under what hypothetical conditions (geopolitical, financial) could we see a dramatic reversal of this trend?
TW: In my “happy” scenario, the global investment in gold is a fixed allocation to bullion so whatever flows out of the ETFs flows into stocks and vice versa. In that case gold stocks are incredibly cheap.
However, that does not reflect reality. We know that a lot of the ETF money is hot in the sense that hedge funds and other investors have diverted cash from other investments into gold.
Some of that went to gold stocks, but most of it - perhaps an increasing portion of it has gone to bullion. In fact, even the dedicated gold mutual funds have less invested in equities than they used to thanks to the availability of the ETFs.
That leaves me pessimistic about how this trade unwinds; and it will unwind. I do place a store in a reversion to the mean, but we lack sufficient data to know what the mean is.
Overall, my conclusion is that investors have withdrawn their confidence in gold stocks as a proxy for gold.
My greatest fear is for a mass exodus from the ETFs that kills the price and implodes the entire sector for a few months.
The best way for gold equities to recover their leverage is to get back to basics – stop diluting stock holders willy nilly, be more circumspect in projections, be more transparent, and get those margins up so that cash balances of $10 billion are not uncommon.
TS: Speculate on the possibility of gold confiscation. Might that inspire more confidence in gold equities?
TW: I have been concerned about confiscation for some time. It’s an example of where the gold conspiracy crowd could have better channeled their energies – to prevent gold from being treated differently from other assets, and to forever block any confiscation or appropriation attempt.
That risk does exist, especially in this era of class warfare. Gold could be construed as an “enemy of the state” in certain conditions. The government has already nationalized companies like GM and Chrysler, and the same pretexts could be used to take private gold. In that scenario, gold equities are not exempt from nationalization activity.
It must be said that the risk is an outlier one; but it cannot be wished away.
For example, if the U.S. hits the wall on its unfunded liabilities, personal gold would be insufficient; they would probably go for gold in the ground as well.
© 2010, MiningStockTalk.com, MineFund.com
Audio of this interview can be found here.
