Good Luck Bargain Hunting for Gold Miners

The miners are no longer a proxy for the metal.

Why bother?

Photographer: Ronaldo Schemidt/AFP/Getty Images

Let's say this right up front: The SPDR Gold Shares Trust exchange-traded fund has killed the shares of the gold miners.

For a few years now, I have been very skeptical about gold's value as an investment. (This may seem excessive, but see this, this, this, this, this, this, this, this, this, this and of course this).

The primary reason is straightforward: Gold is bought and sold based on a narrative that has turned out to be patently untrue. As we move further away from the great credit crisis of 2008-09, the global financial system has stabilized, undercutting the appeal of gold as a hedge against catastrophe. The U.S. economy is improving, as are those of many other countries. The wild inflation and collapse of the U.S. dollar that was going to lead to the demise of civilization and make gold an essential for investors? None of that has happened. Instead the world has low inflation or even deflation and the dollar, the world's reserve currency, has risen to multiyear highs.

QuickTake The Rise and Fall of Gold

Unlike the metal, which is formed in the supernovae of second-generation stars, the rationale for gold ownership isn't eternal. It ebbs and flows along with a variety of inputs, including the strength of the dollar, inflation and, of course, mass psychology.

Last week, rather than discuss the metal, I asked the question "Are Shares of Gold Miners a 'Buy'?" But today's missive is about something more nuanced than gold -- I want to address the question of the divergence between gold and the gold miners. It is a intriguing issue.

gold chart

As I noted, Isaac Arnsdorf at Bloomberg News offered up this fascinating chart of the price ratio between gold and the gold miners. It shows that the miners are the cheapest relative to gold in more than three decades. I believe it is worthy of further exploration -- especially for those folks who are tempted to buy any of the miners now that they seem to be bargains.

What might lead to a return to the historical relationship between gold and gold miners has yet to be determined, but I caution readers that there is cheap, and then there is really cheap. There may be some point where the miners are a good buy relative to the price of gold. But determining when that is has been complicated by a serious breakdown of the gold/gold-miners ratio.

The key word here is "proxy." Gold miners were once a fair proxy for physical bullion. If it were impractical for you as a fund manager to own bars of gold, which entails transportation, storage and security, you had an easy alternative. You bought shares of the miners. The (theoretical) gold reserves they owned was a component of their book value, and was an indirect way to own gold with none of the other costs.

Similarly, if you were an individual investor, and you didn't want to play the futures markets -- high leverage and risk of losses beyond your original investment -- you also could buy shares of the various miners.

Then in 2004 along came the SPDR Gold Shares Trust ETF, which gave both the professional money manager and the individual investor a fast, cheap and easy way to invest in gold.

The ETF killed the primary reason for owning gold miners. Why bother investing in a company saddled with the overhead cost of running a mine and error-prone management -- all a drag on returns -- when you could instantly buy a stake in gold without any of the complications?

The irony is that the gold ETF was a creation of the World Gold Council, an association of global gold-mining companies. In a wonderful history of the ETF, Liam Plevin and Carolyn Cui wrote in 2010 that the gold miners were "frustrated with the council's inability to stem two decades of depressed prices and find buyers for a growing glut of the yellow metal."

The Council succeeded too well: Their creation eroded the need for investors to bother with the shares of the miners themselves.

As I said earlier, there may be some price at which the gold miners become attractive. But it seems like it will be impossible to undo the fact that the reason for owning the miners has been displaced by a less expensive, more efficient investment vehicle for gold.

In that case, good luck figuring out at what price the miners are actually cheap.

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