Its been another one of those odd ball trading sessions where gold prices managed to finish the day up $2.50 to close at $1727.40/oz, but the gold mining stocks, as evidenced by The AMEX Gold BUGS (Basket of Unhedged Gold Stocks) Index, known as the HUI, fell 21.55 points to 447.96 or a staggering 4.59%.
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If we look back two years to the start of 2011, gold was trading at around $1400.00/oz so we can clearly see an increase in its value. At the same time the HUI was trading at around 560 so we can clearly see that this sector has suffered a decrease in value. So those investors who are looking for leverage to the price of gold will have to garner considerable expertise as stock pickers in order to beat the average performance of the gold mining sector. This is difficult to achieve as not everyone has the time that is required to become an expert in such matters. We would also inquire as to why one would take such a risk when the acquisition of physical gold is still relatively easy and it is outperforming the gold bugs index. The operation of mining is fraught with difficulty so one should expect the ‘unforeseen’ to make an appearance from time to time and totally disrupt a mines production schedule. There is also the political risk to be considered, an election can bring with it a new leadership who may require a bigger slice of the profits. Lets face it, there are not too many countries that don’t need extra funding at the moment and asking more from a profitable miner would appear to be a reasonable request.
Back to what happened today. The markets in general also had a bad day with the DOW losing 1.45% and the S&P500 down 1.39%. One swallow does not make a summer as they say, but this is not the first time that the gold mining stocks have been sold off when the underlying asset has remained relatively stable. It also raises the possibility that gold mining stocks are being classified as general stocks so when the market sells off, the mining stocks are also sold off. This is something that we will need to watch carefully in future as it could well be a case of the baby being thrown out with the bath water.
We have been wary of gold mining stocks for some time now and we are still not convinced that they are the best vehicle for gaining exposure to gold prices in this bull market. If they remain neck and neck with gold then the physical metal is the obvious choice, as it is not worth shouldering the additional risks of mining without the reward of leverage.
As investors we are indeed looking to maximize our profits and actively seek out leverage to gold prices. For the last three years or so we have found that trading options in the gold sector has generated better returns than the stocks and until that position is reversed we will not be increasing our exposure to stocks. In fact should the situation revert to the stocks outperforming gold prices then an option on a stock would provide us with a form of double leverage. Imagine it for a moment, gold prices rise by 2%, gold stocks rise by 5% and those stock options gain say, 50%, now there’s a mouth watering thought. We are not dreaming, we do believe that the opportunity will present itself, maybe not just yet, but it will come and when it does we will let you know, as we pounce on it.
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