Commodities

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Gold: It's the shiny talisman that helps paranoiacs sleep at night.

The whole idea of investing is gold is to keep you calm when things look dicey. And with some $9 trillion of sovereign bonds sporting negative yields and scenarios including a Chinese economic crash or a Russia-NATO clash popping up in headlines with disquieting regularity, gold should be doing well.

The price has gained about 16 percent so far this year, so there's that. But, as I argued earlier here, demand for gold has come overwhelmingly from investors, making the rally vulnerable to swings in sentiment. Sure enough, all it takes is some sign U.S. interest rates may rise again soon -- such as this week's home sales numbers -- and the hot money swings away. Gold has fallen 5 percent so far this month, with almost half of that decline coming this week alone.

Sold in May
Gold spot price
Source: Bloomberg

Gold's hardcore fans don't scare easy, though (a bit of Walking Dead action would just prove them right). The ones who might feel a little more nervous are those who bought the stocks of gold miners. Why? Because they've really made a killing.

Dig It
Indexed price performance, year to date
Source: Bloomberg

Granted, the miners have been snapping back from the deepest of bungee jumps: The two ETFs fell roughly 80 to 90 percent in the five years before 2016 as the rapid plunge in gold prices from 2011's all-time peak threw into sharp relief how much debt and costs had built up during the good times.

So it makes sense the riskiest gold-mining stocks have rallied hardest this year as the metal has swung back into favor. The junior miners ETF is beating the larger miners by 11.5 percentage points so far this year. And if we chart the year-to-date total return for 36 North American, South African, British and Australian gold miners worth at least $500 million apiece versus their leverage, you can see it has generally paid to back the heavy borrowers.

Liam-gold-mine-scatter-May2

This mirrors what we've seen elsewhere in the commodities sector. The best-performing stock in the SPDR S&P Oil & Gas Exploration & Production ETF this year is Denbury Resources, which has more than doubled. Specializing in using carbon dioxide to pump oil from older fields, Denbury sports some of the highest finding and development costs in the sector and net debt of more than 4 times trailing Ebitda. More generally, as fellow Gadfly Lisa Abramowicz wrote here, the sell-off in the energy sector's high-yield debt which took off late last year has now almost entirely reversed.

For those who missed the rally, the question is whether they buy in now anyway; after all, the Gold Miner ETF's heroic 63 percent rally so far this year has taken it all the way back up to where it stood ... 15 months ago. The niggling worry with that concerns fractious sentiment around the metal itself. If $1,300 an ounce were to remain a de facto ceiling for gold, then the fascination with highly-leveraged mining balance sheets could fade quickly.

An alternative would be the miners with the less racy balance sheets that haven't rallied quite as hard but at least shouldn't drop like a gold brick if the metal doesn't keep pushing higher. Newmont Mining, for example, had as of Tuesday's close returned a mere 77 percent, slightly below the weighted average for the group in the bubble chart above. On the other hand, its net debt is just 1.33 times trailing Ebitda, slightly above the weighted average. Similarly, Agnico Eagle Mines had returned only 68 percent and has leverage of just 1.11 times.

In judging which gold miners should outperform from here, a little paranoia could be useful.

-- Graphic by Rani Molla

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net