Are Commodity-Focused Investment Vehicles Producing Distortions?

Several observers have begun to wonder why gold stocks have so far been unable to consistently outperform the gold price, in light of the fact that input costs have begun to decline noticeably. In line with this, a number of gold producers have reported improvements in mining costs in recent quarters, which have in many cases accelerated of late (in some cases write-offs continue to weigh on net earnings, but these are non-cash events; also, the value of written down reserves will immediately increase again if/when the gold price rises).

Main shaft of the Kusasalethu deep level mine near Carletonville, west of Johannesburg

Photo via mining-magazine.com

We have previously remarked on the strong correlation between the HUI-gold ratio and the metals and mining stock ETF XME. This correlation at times seemed to make little sense. Our conclusion was that it is likely caused by the financialization of commodities during the expired commodity boom. In particular, investment funds focused on resource companies, ETFs, assorted tracker vehicles and indexes serving as benchmarks, occasionally appear to trigger indiscriminate selling and buying across the “metals mining” sector, regardless of what metals the companies concerned actually mine.

Prior to the era during which all sorts of commodities and commodity producing sectors became ETFs (a symptom of the general move to transform commodities into “investable assets” for investors who are not trading futures or are looking to obtain broad sector exposure), the behavior of gold stocks relative to other metal mining stocks as well as trend in all these sub-sectors relative to the prices of the underlying metals seemed to make more sense most of the time.

However, in recent months the relatively tight correlation between the HUI-gold ratio and XME appears to be breaking down to some degree. Nevertheless, the extremely strong downtrend in XME over the past few weeks and days has likely weighed on the gold sector, keeping many producer stocks from advancing as much as one might have expected during the recent rebound in gold. One must also suspect that strength in South African gold stocks due to the big rally in the Rand gold price has contributed a bit to the correlation breaking down.