Loading ...Trading Arguments Against Holding Gold Stocks
The recent spike in gold and its miners, along with the calls from the bulls to back up the truck on “cheap” gold stocks, may tempt some into getting long the mining sector. We are not so easily convinced. These companies face increasing costs against falling revenue and downward revisions in the value of their assets. This means that the trade is not buying gold miners.
Even if one were bullish on gold, the trade would not be to buy gold mining companies. There exist a number of varied ETFs that offer direct long positions on gold that can be easily traded. GLD is single long gold, DGP is double long, and UGLD is triple long. This means that if one wanted a position that outperformed a gold long by triple, as miners did in the recent spike, then one could easily get that by buying UGLD. This trade would achieve the desired returns if the bullish view is correct without any of the risks involved with gold mining companies.
Suppose that one insisted on having long exposure to the gold mining sector. Buying gold stocks would still not be the best way to go in terms or risk reward dynamics. Consider Hecla Mining, whose debt yields over 17% a year. For a long position on the company’s shares to outperform their bonds over a 5 year period, HL would have to more than double in value. Even in one of the best 5 year periods for gold, 2007 – 2011, gold mining stocks did little more than double. How can one reasonably expect them to perform better than this in an environment where gold is a third lower and more likely to fall than rally?
This is not to mention that in the case that one’s bullish view on gold stocks is wrong and the company starts to lose money. In this situation, the debt has first call on the company’s assets. This means that your downside risks are much higher when holding the stock versus holding that same company’s debt. Given that long debt exposure offers a considerably higher expected return and much lower potential losses, holding gold stocks has poor risk reward dynamics even if one insists on having long exposure.
Therefore, we recommend not holding any long exposure to shares of gold mining companies. It is our view that there is no reasonable situation in which long trades on these companies can offer positive risk reward dynamics. Long trades are simply not compensated well enough for the risks being taken.