MONEY MATTERS
VOLATILE SHARES
BY DOUG FRENCH

Gold investors are constantly faced with a vexing choice. Buy the physical metal — which can now be done in share form — or buy the shares of gold-mining companies. 

Gold mining shares are notoriously volatile as evidenced thus far this year. While gold is trading down just over four percent since the first of the year, gold shares, represented by the XAU index, were down 13 percent through the end of May. The XAU is the capitalization-weighted Philadelphia Stock Exchange Gold & Silver Index that is comprised of 12 mining stocks. 

This disconnect between mining shares and the actual metal has triggered a trading signal called the Gold/XAU: 5.0 Trading Rule. This simple rule is: when the price of gold, divided by the XAU, is greater than 5.0, that serves as a buy signal for gold stocks. According to Myles Zyblock, Royal Bank of Canada Capital Market’s chief North American institutional strategist, “when the ratio is above 5.0 … the average annual one-year holding period return for stocks in the XAU has been 38.4 percent.” 

However, John Doody, in his Gold Stock Analyst newsletter, takes Zyblock to task for starting his system in 1983, “which conveniently allows him to escape the ratio’s initial poor performance in 1980 to 1982.” Doody’s analysis of the data indicates that the system’s return is a more modest 19-percent annual return, still very good. Doody found that traders who bought the XAU at the 5.0 ratio, and held for just three months, earned on average a 82.7 percent annual return. 

The 5.0 ratio was triggered on April 26. The ratio has fallen, but was 4.97 as of this article’s authoring. 

Another gold pro that is bullish on the shares is John Hathaway who manages the Tocqueville Gold fund [symbol: TGLDX]. Hathaway told John Kimelman of Barron’s, “Right now, the shares are very cheap, relative to the metal, so we would-all other things being equal-be liquidating some of our metal holdings and putting them into the beaten-down [gold-mining shares].” 

Hathaway has been adding shares of Toronto-based miner, Agnico-Eagle Mines [symbol: AEM] to his fund. Agnico-Eagle makes up 1.54 percent of the XAU index. 

Terminal gold bull Jim Grant, editor of Grant’s Interest Rate Observer, is bullish on bullion and the shares of Newmont Mining (symbol: NEM). Newmont makes a good share of its profits mining in the Carlin Trend of northeast Nevada, and is expanding its gold reserves in the Silver State. The company “said that its Nevada reserves are the highest in 40 years,” writes Grant in his June 3 newsletter, and “expects to bring 22 million ounces of reserves from Nevada and Ghana on line in the next 18 months at an expected cash cost of $200 an ounce, some $40 or $50 below current cash costs.” 

Newmont is the only gold miner in the S&P 500 and is the largest component of the XAU index at 24.16 percent. Thus, it is the go-to stock for institutional investors who want gold exposure. However, Newmont stock has been beaten down to $36 after trading over $46 in March. 

For investors thinking about gold-mining shares, now might be the time to take the plunge. But, it’s not for the faint of heart. LW