Amid the return of global uncertainty and market volatility, the end of the second quarter of this year has seen off the 7th straight 3-month gain in gold prices. Indeed, no other asset class can compete with gold’s current “for all seasons” performance.
Yet lurking behind the gloss, there is a disturbing sign of global asset underperformance, increasingly shrouded in murky tales of impending deflation. It is a global picture of cash being hoarded by the private sector – companies and households alike. Most of these funds find their way back into the Treasury market of the perceived “safe” (read: sufficiently liquid) countries. Whenever the shift of capital into sovereign debt crosses a currency divide, the returns on gold holdings by local investors are heavily affected. And while gold notched up in the last quarter an impressive 22% in Euro, 16% in Canadian dollars (hitting an all-time high on the last day of June), and nearly 12% in USD, it only yielded pale 4% for Japanese investors.
European investors were the supposed winners in this global rush to capital preservation. Their 22% gain in gold largely reflected the loss of Euro’s purchasing power. A trade-weighted Euro lost 9% this quarter. And while it ceded 22% of its value to gold, it also fell against the Yen (11%), US dollar (9%), Swiss Franc (7%), and the pound – inexplicably buoyed by the market’s infatuation with UK’s new budget. Only the commodity currencies, spooked by the unexpectedly softer Chinese data have lost more ground than the common currency. In particular, the Aussie dollar has been penalized by the capital flight back to Japan.
In response to China’s sobering PMI numbers, the commodity rout has been widespread. Over the quarter, zinc has lost 25% of its value, iron ore 24%, lead 19%, copper 16%. Many of these metals are important buy-products of gold producing companies and can seriously affect the mines’ cost structure. As for oil, the correlation to gold has turned negative and the oft-watched gold/oil ratio hit record spreads twice during the quarter.
But while bullion and gold ETFs offer some solace to those who see debt monetization as an inevitable outcome of the current strains in developed world’s public finances, the mainstream investor is suffering from poor equity returns and scrams headlong into the Treasury market. Increasingly signaling serious deflation risks, the 10-year US Treasury yield dipped below 3%, bringing the returns to 4% over the quarter.
Not surprisingly, a crater has opened underneath the global equity market. In the flight from risk, global equities (MSCI world) returned negative 13.5% this quarter, while S&P500 has lost 10.9%. By comparison, the gold stocks’ performance has been stellar, yet in absolute terms it has been all but.
In fact, as the gold price continues to advance across all currencies and the commodity currencies are now suffering from China jitters, the returns on gold mining stocks have been trailing, yet again, the bullion’s gains. In a mean-reverting industrial commodity, such a yawning discount to NAV would presage a sudden collapse of the value of the underlying commodity (as was the case with many commodities two years ago). Are gold stocks now sending a warning shot?
In fact, the performance of global gold stocks varied widely. Asian equity markets are a depressing spectacle these days. Hong Kongers in particular are happy to swap their wealth into a bet on an IPO of one Chinese bank. Hong Kong market has lost 6.5% over the quarter and its gold stocks returned “only” 11.25%. Australian gold companies enjoyed somewhat of a late rally in June, leading to a 12.6% return. In North America, gold mining companies compare favorably to the broader market: GDX index returned 17%, HUI index 16%. The biggest winners were South African miners, with 17.9% return (most of which occurred in April – May) and London-listed gold stocks with an impressive 20.69% vs only 13% gains for bullion denominated in the British Pounds. London is one market which continues to favor gold equities over ETFs – a fact certainly not lost on the executives of the nascent Kazakhgold/Polyus giant.
All this means that the global equity sell-off has affected the performance of gold stocks even though the companies’ top line, cost of capital, inflation pressures and currency movements have all conspired towards higher margins. Indeed, since gold stabilized after hitting the most recent all-time high in USD terms (June 18), North American gold stocks have slipped around 3%. At the same time, exploration stocks, as measured by GDXJ index, have tumbled 9.2% and returned a relatively paltry 8% over the quarter. Not surprisingly, most exploration-focused gold funds registered a loss.
It is hard to imagine that the monetary and fiscal authorities would stand idle if the global economy began to slide into deep deflation, a scenario which may not bode well for the gold market. Yet many of the gold stocks are now attracting multiples more akin to industrial sectors dependent on the robustness of global demand. The outcome is binary. Either they are becoming a dangerous value trap, or should be treated as a tremendous opportunity should the current deflationary scare ease.
Tags: gold and currencies, gold exploration stocks, gold quarterly performance, gold stocks
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