Max Pacella
Investment Analyst
Macro & Markets
22 Apr, 2021


That’s a word that hasn’t been in popular favour for a few months.

After breaching record levels of $2,050 USD per ounce in August 2020, the gold spot price unceremoniously collapsed over 18% over the next seven months, currently sitting just below the $1,800 USD level.

Source: Bloomberg

There are multiple reasons for the spot price moving the way that it has, which we will cover off in a moment.

But today we want to look beyond this chart, to the miners themselves – what are the mechanics of investing in gold spot versus gold miners, what are their characteristics and how does that fit into your portfolio?

Gold Spot

For the sake of this brevity, we will set aside the industrial demand for gold as a commodity, to discuss how sentiment and other asset classes influence the spot price – most portfolios consider asset class correlation vastly more than they do the global demand for jewellery or wiring.

If you take this point of view, then you play by the common saying:

“Gold is worth what people think its worth”.

To put that in a more economic way, gold is known as a ‘risk-asset’, a place where investors move their capital in search of a “safe haven” if stocks are selling off or the economic environment is proving undesirable – you’ll hear this referred to as a “risk-off” environment.

Taking this to the absolute extreme interpretation, if an investor buys gold (and we assume they have no intention of selling) they are anticipating that the USD or other fiat currencies are going to become irrelevant and they’ll need a physical currency to use as a medium of exchange.

This above example is hyperbole, but illustrates the sentiment buying the investment.

So why did the gold spot fall and why is it showing a bounce-back since March?

Largely, sentiment regarding the US economy, the dollar and inflation; perhaps the above wasn’t hyperbole after all.

Investors took a risk-off sentiment after concerns grew about record levels of fiscal stimulus and money being printed by the Federal Reserve – which has multiple flow-on effects;

  • Expectations of higher levels of inflation enter the marketplace
  • U.S 10-Year Treasury yields are brought into focus as these indicate the cost of borrowing for governments and companies as the debt increases
  • The strength of the USD is questioned, but at this point the wave of retail investment into Bitcoin has made it a more attractive risk-off play than gold

Gold has now increased from ~$1,700 USD in March, coinciding with both market sentiment around U.S 10-Year yields and a sell-off in Bitcoin. The economic implications of these events have a large impact on the views of the market.

Jesse touched on correlations last week, what we see here is an overwhelming force of market sentiment coupling with the inverse correlation between an alternative (Bitcoin) coming together to drive the price.

Source: Bloomberg

After all of that, how does gold fit into a portfolio?

To buy gold directly, through vehicles such as the iShares Gold Trust (IAU), is to espouse a directional view on the sentiment of the market.

This includes the sentiment around economic health in major markets, the valuations of equities, the yields of bonds and the performance of alternatives such as Bitcoin.  

Keep in mind that, whist the market fretted about the stability of the S&P 500 after the March collapse of 2020, gold outperformed that index by over 6%, rising by 24.6% whilst the S&P delivered 18.4% (Bloomberg).

You may have bought gold because of concerns around the Fed printing money, but you still would have been swept up in the rally of a different economic concern.

This is just one example that shows that owning gold directly in a portfolio today, possibly more than ever before, is taking a very strong opinion on a wide set of market conditions.

Gold Miners

On the other hand, to buy a gold miner is to buy a company with a balance sheet, profit forecasts, physical assets and access to capital markets.

In other words, a very different investing profile, whilst still getting exposure to a similar sentiment theme.

One of the primary factors in the profitability of a gold miner, arguably more so than the gold spot price itself, is their cost of production – what is the per ounce cost to mine and process the gold?

If a miner can reliably produce gold (without getting into the technicalities of quality/purity for this discussion) at a price of $500 p/ounce, then the profitability of the company is very secure regardless of if the spot price is at $2,000 or $1,800.

But if you are investing into a high-cost miner, or are looking to purchase a junior miner (a company in search of new deposits), then this is a much more bullish view on gold since you expect the price to be sufficiently high to be profitable/justify a purchase of the junior miner respectively.

Another factor to consider is the ability of owning an equity to ‘leverage’ your way into a directionality view on gold (and the factors influencing it iterated in the last section):

Stocks trade at a multiple of earnings, generally price-to-earnings (P/E) ratio. This ratio means that through exposure to one miner, the investor can have hypothetically increased exposure to the movement of the gold spot price;

  • Miner A produces gold at $1,000 per ounce (assume this is the only cost)
  • The gold price is currently at $1,100 per ounce
  • If the gold price increases by $100, then the profitability of Miner A increases by 100%
  • If Miner A is trading on the stock market at a P/E ratio of 10x, then the investor has hypothetically just leveraged their upside of the increase in gold by 10x

This is a simple example and does not necessarily reflect all ways to play the miner investment – you could be looking for an extremely positive event like finding a new vein, or finding large miners with low costs of production to secure a reliable profitability without concern for if the spot price goes up or down by a few hundred dollars.

To buy larger miners such as Newcrest (NCM:ASX) or Northern Star (NST:ASX) is more likely a play into company profitability, as well as the larger correlation with the equity market due to their size in the Australian market.

To buy smaller miners (preferably with low costs of production and developing projects), such as Westgold (WGX:ASX), Resolute Gold (RSG:ASX) or Dacian (DCN:ASX) is more leveraging the actual gold price to generally espouse more of a view of seeking capital upside based on the gold price (or sentiment around gold).

This means that the universe of gold miners can offer a vast range of investment themes all centred around the broad strategy of exposure to gold.

The mix of dynamics associated with owning a miner (as opposed to exposure to the spot price directly) means a different implication for a portfolio – one which leverages both company operations and commodity price movements, as opposed to purely a directional bet.

All that Glitters is Not Gold

Gold is in a complicated place in the market at the moment – as with many other asset classes, it is encountering many ‘firsts’ from hitting highs to encountering one of its most fierce competitors from the retail flows into Bitcoin.

Today, gold represents a largely sentiment-driven investment, one which needs to be carefully considered in both the direction and vehicle in which to get exposure. There are winners and there are losers in both miners and the direction the portfolio is exposed – and this can change rapidly based on global markets.

The aphorism “all that glitters is not gold” has been around for over 500 years, and the warning is no less relevant for investors here – although in this case, perhaps it is better phrased as “all that is gold is not profitable”.

The views expressed in this article are the views of the stated author as at the date published and are subject to change based on markets and other conditions. Past performance is not a reliable indicator of future performance. Mason Stevens is only providing general advice in providing this information. You should consider this information, along with all your other investments and strategies when assessing the appropriateness of the information to your individual circumstances. Mason Stevens and its associates and their respective directors and other staff each declare that they may hold interests in securities and/or earn fees or other benefits from transactions arising as a result of information contained in this article.