Where Is Gold's Real Leverage?

Over at Zero Hedge there is a rant about how gold and gold stocks are better investments than the stock market and how there is a Wall Street conspiracy to suppress the gold price and keep the "dumb" investors in stocks.


With the Bank of Japan's latest move to fight deflation and seemingly to start another round of global competitive currency devaluation, it does certainly make some sense to hold some gold in a portfolio. However, I remain of the opinion that it makes no sense for gold bulls to hold gold stocks over bullion. Consider this chart below of the price of gold compared to the Amex Gold Bugs Index (HUI).


The top panel shows the price of gold in black and HUI in red. The bottom panel shows the HUI/gold ratio. A rising ratio indicates positive leverage to gold and a falling ratio shows falling leverage. The HUI/gold ratio rose and peaked out in late 2003. It then flattened and started to decline in 2005 and continues to fall today.

I wrote about this topic in 2011 and 2009 and it continues to be true: Gold bulls shouldn't buy gold stocks! The reason why gold stocks have failed to keep pace with the price of bullion: gold mining companies can't replace lost production at the same cost at which the older, cheaper ore bodies were mined out. They are mining lower and lower grade ore and therefore their profits and cash flows are lower because of higher production costs (see my analysis Valuing gold stocks on cash flow, not assets).

Bottom line: If you are a gold bull, buy physical gold, the gold ETF (GLD), or a commodity fund such as the Central Fund of Canada (CEF), or any other vehicle directly related to the price of gold. Just avoid gold stocks.

Disclosure: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.