How Long Will Gold Miners Lag Bullion Prices?

As we have previously discussed, the gold miners continue to lag behind bullion prices.  In the past six months, the SPDR Gold Shares ETF has increased by nearly 10%, while the Market Vectors Gold Miners ETF has declined by 5%.  The disconnect continues as traders feel uneasy about equities and elevated gold prices.  When it comes to panic and confusion, cash is still king on Wall Street.  However, another well-known investor is endorsing gold mining companies, a sign that gold miners may finally catch up to bullion prices.

Hedge-fund manager and Greenlight Capital chairman, David Einhorn, believes that the growing disconnect between gold miners and bullion prices will reverse course.  He said, “A substantial disconnect has developed between the price of gold and the mining companies.  With gold at today’s price, the mining companies have the potential to generate double-digit free cash flow returns and offer attractive risk-adjusted returns even if gold does not advance further.  Since we believe gold will continue to rise, we expect gold stocks to do even better.”

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Mr. Einhorn, who is also the President of Greenlight Capital, cut his gold commodity holdings in the third quarter and moved those funds into the Market Vectors Gold Miners ETF.  According to Bloomberg, in a regulatory filing on October 31, Greenlight Capital states, “Given the challenging macroeconomic environment, we intend, for the foreseeable future, to continue holding a significant position in gold and other macro hedges in the form of options on higher interest rates and foreign exchange rates, short positions in sovereign debt and sovereign credit default swaps.”  We also believe that gold should be held as a hedge against the macro headwinds facing the world.  On Monday, MF Global filed for bankruptcy after placing highly leveraged bets on euro zone debt.  What’s troubling, is that the company had credit default swaps, but since the 50% Greek haircut was classified as voluntary, it did not count as a credit event, so the credit default swap insurance was rendered useless. Gold remains the ultimate insurance.

Several miners are not waiting for the disconnect to end in order to provide shareholders with returns.  Last week, Barrick Gold announced a 25% increase in its dividend payout.  IBTimes reports, “Over the last five years, Barrick has had a consistent track record of returning more capital to shareholders, increasing its dividend by more than 170% on a quarterly basis.”  Strong earnings and operating cash flows have allowed miners to offer increasing dividends.  Earlier this year, Newmont made a popular move with shareholders by linking its dividend to the price of gold.  After the second quarter, Yamana Gold increased its dividend by 50%.  Along with Mr. Einhorn, gold miners believe that gold prices will rise, and it shows by the dividend policies taking place in the industry.  Furthermore, gold futures traded in New York may rise 12% to $1,950 an ounce by the end of the first quarter, according to the median of estimates collected by Bloomberg.  The predictions are from eight of the top ten analysts tracked by Bloomberg over the past eight quarters.  Higher or even stable gold prices provide a bullish scenario for the miners.  A scenario that investors are quickly positioning themselves for, in order to take advantage of the coming correction between miners and bullion prices.

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