“As always, thank you for all of your hard work, insight and incomparable market service. Was wondering if you had any speculation as to why gold miners such as ABX, AU, NEM and IAG generally peaked relative to the price of gold (simply taking the price of the stock and dividing by the price of gold) in the 2003/2004 timeframe and have declined markedly since? These declines seem rather overdone given strength in the price of gold over the same period and a reasonable expectation for continued strength in the price of bullion. “

Eoin Treacy's view Thank you for this topical email which I'm sure will be of interest to subscribers. Between early 1996 and late 2000, the NYSE Arca Gold Bugs Index dropped from 220 to 36 reflecting a massive underperformance relative to the gold price which approximately halved during the same timeframe. However it is also relevant that gold shares bottomed well ahead of the gold price, helping to explain their outperformance in 2001 and 2002. This latter period helps to explain the 2000/2001peaks in the ratios of Barrick Gold, Anglogold Ltd, Newmont Mining and IAMGold relative to gold.

Their subsequent underperformance can most likely be attributed to the obstacles faced by any mining operation. Mines are a wasting asset by definition. Therefore mining companies need to constantly invest to prolong mine life and to gain access to fresh seams. Over the last decade, the costs associated with mining have ballooned as competition for energy, labour and machinery increased. Resource rich countries have also become considerably more active in asserting their rights and have been demanding increasingly more generous royalties. Concurrently, gold miners have been slow to increase pay-outs, which in a yield hungry environment has acted against investor loyalty.

On the other side of the equation, and as demonstrated in 2001, gold miners and the less liquid precious metal contracts such as silver, platinum and palladium can perform as high beta instruments relative to gold when investor interest returns to the sector. Gold shares have also outperformed over the last month.

This is particularly relevant at present because gold mining shares pulled back so sharply between March and mid-May. They are currently in the process of unwinding a deeply oversold condition relative to the 200-day MA while gold has steadied above the psychological $1500 level. Provided gold continues to find support above that level, the medium-term outlook for gold miners is likely to remain favourable.