2016: The next gold rush

Gold is one of the most traded asset classes in the world.  According to the World Gold Council¹, “Gold ranks higher than all European sovereign debt markets and trails only US Treasuries and Japanese government bonds.” For investors gold has been seen as a safe haven for portfolios however gold does not pay dividends and there are costs for storage and insuring gold.

One way investors can get exposure to fluctuations in the gold price is via gold equities. Gold equities are traditionally correlated to the gold price.  However there have been periods since the GFC in which gold equities have gone in a opposite direction to gold. Despite the price of gold being 50% higher than at the beginning of 2009 and the rise in equity markets over that time, gold equities are in the deepest and longest bear market in history.

A recent study by academics in the UK, “Are Gold Bugs Coherent?²” concludes “that there is little relationship in the short run but some significant and long standing long run relationships” between the prices of gold equities and the price of gold bullion.   The current market is testament to the short run findings.

The paper tested a period that included the bottoming of the gold price at just over US$250 per ounce in 1999 through to its nominal high at US$1879 per ounce in 2011.  The authors used a sophisticated mathematical technique called wavelet analysis.  Wavelet analysis has been applied for many years to mathematics, physics, engineering and meteorology. Academics have now expanded its use to econometrics and finance.  The maths involved is too complex to explain here but the results of the paper demonstrate that for periods one year or greater the prices of gold equities in general follow the gold bullion price.

Further, an earlier study by the same authors analysed the relationship between gold prices and production costs³.  They found strong evidence linking gold prices to gold production costs.  We have seen this recently.

As the price of gold has fallen since its 2011 peak, high cost mines have been forced to shut down.  According to Goldman Sachs Investment Research the cost of gold production is declining as management curtail costs and the industry benefits from fuel and currency savings.  The result is an overall fall in the cost of gold production.

“Both sets of results imply that (gold) miners do well in a rising (gold) price environment as the gap between costs and prices widens in their favour.” (Lucey and O’Connor, 2016).

Since the beginning of the year the price of gold bullion has increased over 6% (as at 2 February 2016) as investors seek a safe haven from increased equity market volatility.  In the medium to long term, according to wavelet analysis, should this “risk-off” continue the price of miners should follow.

Australian investors can capture the potential upside on ASX with GDX, the largest global gold equities ETF in the world.

GDX gives investors instant access to 39 of the largest and most liquid global gold mining companies in a single trade on ASX.

GDX is the most traded gold equities ETF in the world with ~A$1 billion traded daily on NYSE.  GDX's popularity with brokers, financial advisers, hedge funds and retail investors has made it one of the US' top 20 traded US funds (NYSE Arca, ETP Monthly Flash Report, December 2015).

If you would like more information on GDX please contact our ETF specialists on 02 8038 3300 or email us at info@marketvectors.com.au

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¹World Gold Council (2011).  Liquidity in the global gold market

²Lucey, Brian and O’Connor, Fergal (2016).  Are Gold Bugs Coherent? Social Science Research Network.

³Lucey, Brian, O’Connor, Fergal and Baur, Dirk (2015).  Do Gold Prices Cause Productions Costs?  International Evidence from Country and Company Data Journal of International Financial Markets, Institutions and Money.