Dont expect the gap between bullion and gold equities to close soon

(July 5, 2012 - by Geoff Candy)

The current dislocation between gold equities and bullion has been heavily debated but, is it temporary or indicative of a fundamental change?

GRONINGEN (Mineweb) - Much has been made recently about the gap between prices of gold equities and the underlying metal. Depending on which side of the fence they are invested commentators take it to mean bearish things for bullion or very bullish ones for the gold equities.

Tom Kendall, director of commodities research at Credit Suisse, maintains however, that one shouldn’t read too much into the dislocation in the current market.

Speaking on Mineweb.com’s Gold Weekly podcast, he said, there are two key factors that make him cautious about interpreting anything from the discount of gold equities to the underlying price.

The first, he says, is that "the metric and the way that gold equity discounts are measured have changed significantly over the last three or four years." In part he adds, "that’s linked to the growing popularity of physically backed exchange traded funds in gold."

This comment echoes similar ones made by other commentators to Mineweb over the last few months who have noted, not just the  impact of gold ETFs on the price of gold equities but, indeed the changing nature of gold equity investment as a whole.

ASA’s David Christensen explained it to Mineweb at the end of 2011 in these terms, "Right now the [gold] mining companies are trading more akin to the cyclical heavy industry mining and base metal companies of the past. ...it’s very true there has been much broadening if you will of alternative investments to look at in terms of precious metals that weren’t available to investors in the past."

While Eric Coffin of HRA Advisory, added this to the argument in an interview with Mineweb last year , "If you look at the long term trend - if you go back to the start of this bull market about 10 years ago when gold was more abundant - sitting at $280 - gold stocks generally - I’m talking about larger producers - they generally carried PE ratios in the 30 range which was quite high in relation to the rest of the market.  And at those gold prices, people were buying the reserves if you will - they were paying a premium to get a call on a higher gold price."

With the price of bullion significantly higher now, he said, the "premium that people are willing to pay for the call on higher prices is getting smaller and smaller and gold stocks are simply beginning to trade more in line with PEs of other business sectors and we think that’s pretty much the way it’s going to be going forward."

The second reason Kendall posits for the current dislocation in prices is the tremendous number of operational and geo-political issues the gold equity sector must consider and absorb at the moment.

"Look, for example, at what is going on in Peru at the moment with Newmont’s planned project there, it’s just one example of the heightened political risk."

He adds though that while it is very difficult to read anything into the discount currently, "It certainly is very wide and perhaps one should expect it to close over the long term but, there has got to be quite a lot of fluctuation in the meantime I think."

And, even when, or perhaps if, it does close, the question becomes, just how closely will it resemble the relationship of old?