Reply #8: Why Gold Stocks Have Not Performed…Yet By Chris Mayer [View All]

[Demeter]

For the first half of the year, the HUI Gold Bugs Index — made up of gold mining stocks — was down 9%, despite the fact that the price of gold was up 30%. What gives? Normally, gold stocks give its investors some leverage to the gold price. Historically, gold stocks move 2-3% for every 1% move in gold. Not so in 2011. There are some reasons for this. In order of importance, I rate them as follows:

1. The cost of production is up a lot. Energy costs represent 20-35% of costs. Then there are steel costs, chemicals and labor — not to mention declining grades, which mean chewing through more rock per ounce of gold mined. As a result of these rising costs (and the next bullet), cash profit margins for the industry are not much higher than they were three years ago, even though gold is much higher. There is little relief coming here, though the retreat in the price of oil helps. This can also be turned around, however, as a positive for some low-cost, high-margin gold miners. It makes their properties all the more valuable and gives you a good cushion investing in them.

2. Taxes have gone up huge. CIBC notes, in a recent report, that cash taxes per ounce mined have gone up 1,200% in the last six years! Put another way, taxes are up to about $200 an ounce from under $20 an ounce six years ago. This is a statistic that went from practically meaningless to heavy anchor in just six years. Again, there is little relief coming on No. 2. Political risks will probably play a bigger role in gold mining as gold prices rise, giving politicians incentive to take more. Nationalization? Confiscatory taxes? These are concerns. Again, this can be turned around as a positive for gold stocks in safer jurisdictions.

3. There is much skepticism about the price of gold holding its big gains this year. As a result, there is reluctance on the part of investors to give gold mining shares the full benefit of the price increase when they think about what they are worth. You can see this in Wall Street research in which analysts assume lower gold prices going forward.



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