Are Gold Stocks Too Cheap Vs. The Price of Gold?

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Political unrest in Europe has pushed risk button and sent havens like the US dollar and gold higher. Gold knocks on the door of $2,000 an ounce for the second time and we see the third turned to a major breakout above $2,000 an ounce.

Are gold stocks TOO cheap relative to the price of gold?

Katusa Research, Bloomberg

Gold stocks against the price of gold – Too cheap?

We have received many emails explaining why gold stocks are not performing as well as the metal itself. If you are confused, you are not alone. On average, gold stocks are up a higher percentage than the metal. But it’s true, gold stocks “should” be higher given the leverage effect of the price increase. There are several reasons why gold stocks failed to meet expectations for $1,950 gold.

  • Institutional investments in the gold sector lead to large stock purchases that drive prices up or down.

The “paper gold” market (which consists of gold-backed ETFs) has seen billions of dollars inflow. But miners have not seen the same capital inflows. This means that the silver is for direct exposure to gold, not for exposure through shares of gold mining companies. The chart below shows the institutional fund flow history for all physical gold ETFs, including GLD, IAUand GLDM.

Are gold stocks TOO cheap relative to the price of gold?

Katusa Research, Bloomberg

  • You’ll see that March 2022 was one of the biggest net gold-backed ETF buys since gold ETFs first came into vogue in 2008.

The question really is… How good are the pros at timing their big purchases?

Follow the money: flow of gold funds

Since 2008, the average net positive fund flow has been just under $900 million per month. There have been 6 times since 2008 when fund flow purchases during the month exceeded $5 billion. Let’s compare gold price action on a very high conviction basis ($5 billion+ in monthly fund flow) versus a 2x average flow (for convenience let’s call it $2 billion per month).

Are gold stocks TOO cheap relative to the price of gold?

Katusa Research, Bloomberg

In the short term, the difference is minimal or perhaps even less in favor of big buys. But over the longer term, very high conviction buys outperform.

No stress? The passive way to own gold stocks

In reality, there are a small handful of individuals who have the technical and financial acumen to beat sector ETFs. This is one of the main reasons why ETFs have become so popular. These sector ETFs provide exposure to the commodity or risk factor an investor is looking for, without having to get their hands dirty. Gold miner ETFs are no exception to this role.

  • Key point to remember: The capital that passively flows into the gold mining sector is only a fraction of what goes into the physical gold market.

Below is a chart that tracks this fund stream creation and redemption activity for ETFs.

Are gold stocks TOO cheap relative to the price of gold?

Katusa Research, Bloomberg

Comparing the fund flow of physical gold-backed ETFs versus miners is an incredible difference. You would think they would trade in similar directions. But this is not the case. If you look at the cumulative cash flows side by side, the difference in investor appetite is incredible.

  • The big funds didn’t buy gold miner ETFs, but they did buy physical gold ETFs.

The chart below shows the cumulative fund flow for the paper gold market versus the gold miner equity sector, as of January 2017.

Are gold stocks TOO cheap relative to the price of gold?

Katusa Research, Bloomberg

Since January 2017, ETFs that offer exposure to gold mines have experienced a sharp decrease in cash flow. Meanwhile, ETFs that hold direct exposure to gold added $40 billion. Since the COVID pandemic:

  • Paper-gold ETFs saw inflows of $23.5 billion.
  • Miners have recorded outflows of over $1 billion.

This should have contrarian investors salivating. This latest chart shows that gold miners’ risk appetite just isn’t there right now. The speculative money that has historically driven gold stocks (especially microcaps) is likely caught up in cryptos and NFTs. That said, I don’t see the geopolitical landscape improving in the near term, which should mean that safe-haven assets will continue to see strong bids. I think tensions will continue to rise but will eventually dissipate in Europe. This will lead to major moves in the markets. Some industries will capitalize, and others will be decimated. Sincerely, Marin.

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