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Debunking Gold Miner Myths: They Aren't a Leveraged Play on Gold - Analyst

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(Kitco News) - When it comes to investing in the miners, there are a few concepts that have come to be investor convictions but, they are no more than just simple myths, says one analyst.

Charlie Bilello, director of research at Pensions Partners, highlighted two very popular ‘myths’ when investing in gold miners that he chose to debunk: gold miners are a leveraged play on gold and/or gold miners are a good hedge against the S&P 500.

“If you own the miners as a leveraged play on gold or as a hedge to the S&P 500, you may want to reevaluate that rationale. If you don't, you're likely to be disappointed by their actual behavior,” he wrote in blog post Tuesday.

“That's not to say that you should never own Gold Miners, but your reasons for owning them should ideally be based on something more than a myth.”

To make his case, Bilello analyzed both the world’s largest gold-backed ETF SPDR Gold Shares (NYSE: GLD) and VanEck Vectors Gold Miners ETF (NYSE: GDX); and, looking at the first so-called myth, his analysis showed that GDX has not actually been a leveraged play to GLD.

“Since its inception the Gold ETF has advanced over 84%. If you assumed that Gold Mining stocks would be up some multiple of this amount, you would be mistaken. Gold Miners have actually declined over 36% during the same period,” he wrote.

“For starters, there is no formula that states that the Miners have to return x% of Gold. They are not commodities but stocks, and as such their returns are dictated by dividends, earnings growth and multiple expansion/contraction. While these factors are undoubtedly influenced by the price of Gold, they are not ruled by the price of Gold.”

Bilello explained that even if the two securities are related and often move in the same direction, it still does not necessarily mean it is a leveraged play.

“[T]hey often move in the same direction…But often is not the same as always, and correlation is not the same thing as performance,” he said. “After trading largely in line with Gold from mid-2006 through mid-2008, the gap between Gold and the Miners widened significantly in the back half of 2008 when the Miners went into free fall.”

Miners vs. S&P 500

As for the second ‘myth’ in question, Bilello said the GDX is not always a good hedge against the major U.S. stock index. 

“Since its inception in 2006, GDX has a Downside Capture of 60% versus the S&P 500 and has been down 53% of the time when the S&P 500 is down,” he said.

“It has basically been worse than a coin flip to bet that Gold Miners will be up in a down market for stocks broadly.”

However, there is some validity to the claim, but Bilello argues exactly that – “some” validity only.

“They certainly can be [a hedge], as they are up 47% of the time when the S&P 500 is down. But one can hardly say that they are a ‘good hedge’ when they are down 38% in October 2008, one of the worst months in history for the S&P 500 (-16.5%),” he said.

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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