The second column shows Goldcorp’s share price in US dollars and the third column shows its share price in Canadian dollars. The fourth column is the US dollar-Canadian dollar exchange rate and the last column is the Canadian share price multiplied by the exchange rate.
The table shows that Goldcorp’s shares increased significantly more in US dollars than they did in Canadian dollars. But by comparing the second and the last columns you can see that a US investor would not have gained anything from buying the shares in Canada, in spite of the fact that the Canadian dollar appreciated 16% against the US dollar since May. Whether he bought the stock in the US or in Canada, his gain would have been the same (37% versus 36%).
It actually makes no difference where the stock is listed, what matters is where the mining company’s projects are located. Here’s why.
Let’s imagine two identical mines, one in the US and one in Canada. Let’s further assume that the US mine’s production cost is US$300 an ounce and the Canadian mine’s production cost is CAD$400 an ounce.
On May 1st the US mine made US$87 an ounce profit while the Canadian mine made CAD$131 an ounce profit. By December 1st the US mine’s profitability had increased to US$155 an ounce (78% increase) while the Canadian mine’s profitability increased to CAD$138 an ounce (5% increase). In the case of both companies, the increase in profitability was due to the increase in the gold price in their respective currencies.
A mining company’s value depends on the value of its mines. Because of the decline in the US dollar, the US mine’s profitability increased by 78%, which makes the company at least 78% more valuable, while the Canadian mine’s value hardly increased at all since the gold price in Canadian dollars increased by only 1%.
A Canadian investor investing in the US mine would have gained 62%: the 78% increase in the value of the mine less the 16% decline in the value of the US dollar against the Canadian dollar. That is still much more than the 5% he would have made if he invested in the Canadian mine.
A US investor would have made 21% if he invested in the Canadian mine (16% plus 5%), but that is pale in comparison to the 78% he would have made on the US mine. And if he wanted to use the proceeds from his investment in the Canadian mine to buy any imported item, or go on vacation outside the US, he would lose the benefit of the 16% rise in the Canadian dollar. To benefit from the rise in the Canadian dollar he would have to spend his gains in US dollars.
In our earlier example, Goldcorp’s shares increased 18% in Canadian dollars between May and December. The increase in the value of the company due to the rise in the Canadian dollar-gold price was almost nothing, leaving me to assume that the increase in the company’s stock price was due to increased demand from investors based on the increase in appetite for gold stocks in general.
By now many people are paying lip service to the fact that the US dollar-gold price is linked to the US dollar exchange rate, but few people bother to think about the ramifications. When the gold price in US dollars goes up, they buy all sorts of gold stocks.
As time goes by, those who bother to read financial statements might eventually figure out that the mining industry’s cash flow is highly dependent on where the mines are located, and the market will become more efficient. In the meantime you have the opportunity to position yourself before the masses become enlightened.
Any investor, American or otherwise, can gain leverage to the decline in the US dollar by buying companies with deposits in the US. For Canadian, or Australian, or South African gold mines to be good speculations, the gold price has to rise in their respective currencies. That means investors in gold, and commodities for that matter, have to consider currency fluctuations in addition to other variables when making investments.
Paul van Eeden
Paul van Eeden works primarily to find investments for his
own portfolio and shares his investment ideas with subscribers to his weekly
investment publication. For more information please visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.