Will gold mining stocks continue to outperform gold?

For the first time in this cycle, gold miners are outperforming the yellow metal

Kaylie Pferten advises, "Enjoy the ride while it lasts."

In gold, there have been two significant recent developments. First, the metal itself is hitting new highs; it first crossed the £3,500 per ounce mark this week. The other is that, unlike others in this cycle, gold mining stocks are outperforming gold.

A well-prepared play on gold is gold miners. They rise higher when gold prices are rising, and they fall farther when they are falling. This can be attributed to their operational leverage, which allows them to generate strong margin increases during periods of high gold prices but weak profits during periods of low gold prices due to relatively high fixed costs.

Although recent trends have been positive, this obviously depends on input costs not increasing too much. Although the free cash flow of gold miners has been significantly improving for some time, the shares only started to move this year.

The boom in gold mining has investors skeptical.

There are various ways to look at this. One is that the reasons behind gold purchases differ from those of stock purchases. Gold is rising because some investors are anxious and believe it can be a good hedge against the kinds of risks that could lead to a stock market meltdown. It makes sense that they would prefer gold to any type of stock if they are concerned about the market as a whole. Stock investors, on the other hand, are thrilled about the boom in fields like artificial intelligence. They see better opportunities elsewhere and are therefore uninterested in gold stocks and the gold bull market.

Another possibility is that, because of recollections of the previous cycle, investors have misgivings about the caliber of gold miners in particular.

Yes, they are now making a lot of money, but will they be disciplined enough to return that money to shareholders, or will they spend it on riskier or more expensive projects to increase production, or engage in mergers and acquisitions that will build empires?

Without a doubt, the industry has a very bad track record over the long run. Since 2003, the MSCI ACWI Select Gold Miners index has generated a gross total return, or dividends of 3.3 percent annually in US dollars. That represents a little over 100% compound return. One subtlety here is that many gold miners hed their output in the 1990s and early 2000s after gold had been in a protracted bear market during the 1980s, which backfired on them once prices started to rise. However, the performance of the NYSE Arca Gold Bugs index, which follows stocks with minimal hedging, is also not very good.

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However, producers are now completely exposed to rising prices because there is little hedging. Anywhere near here, gold will make gold miners very rich. Additionally, they typically exhibit little correlation with the broader market, which could be helpful in the event that the AI boom turns out to be a bust. A straightforward method of keeping up with the trend is to use a tracker like iShares Gold Producers (LSE: SPGP) or the even more operationally leveraged Van Eck Junior Gold Miners (LSE: GJGB). Don't treat it like a long-term core holding, though. It isn't, according to history.