Gold and the Canadian Investor

If you're a Canadian investor in the gold sector, it is quite possible that your returns don't seem to be as good as the headlines would have you believe. Gold is breaking to new highs every second day, but is your portfolio benefiting?

I know that last sentence sounds like a sales pitch, however it isn't; I simply want to talk about the gold market from a Canadian perspective since it is not the same as it is for an investor in the US, which is the source for much of the media noise. One big difference is the currency. Do not be misled by the quoted price for this precious metals commodity -- or indeed for most commodities -- since they are quoted in US dollars, and that currency is faring poorly. Consider the adjacent 12-month charts: one for the commodity and the other for the loonie's exchange rate with the US dollar.

In rough numbers, gold has risen from about US$800 to US$1,150 (the quoted ETF -- GLD -- is an approximate proxy for the underlying commodity). During the same period the loonie has risen from about $0.81 to $0.95. If you invested in commodity futures or an ETF, in Canadian dollars your return is about 23%. Gold itself rose 43% against the US dollar. In other words, for every 1% rise is the US-denominated gold price, your investment returned 0.5%. That's one good reason, as a Canadian, to be wary of the hype surrounding commodity bull markets.

There is an alternative to the commodity and that is to invest in the producers: the gold miners. Consider the adjacent chart of one popular gold miners index. (Yes, while it is a US index, many of the worlds' major gold producers are Canadian and trade on exchanges in both the US and Canada, and, in general, perform similarly.)

The chart's shape is similar to that for the commodity, except look at the numbers. Over the same 12-months, the index has risen from about 23 to 51, and increase of 122% in USD and 89% in CAD. This is unsurprising since company profits typically are a multiple of the commodity. The reason is simple: if it costs a producer $500 to produce an ounce of gold, the profit is $300 when the commodity sells for $800 and $650 when the price is $1,150. That performance is why the producers outperform the commodity. Of course, and most importantly, the same reasoning works in reverse when the commodity price declines. The downside risk is in proportion to the upside opportunity!

My message is simple enough: if you are a Canadian who feels tempted to invest in gold, think carefully before investing in the commodity itself. The potential returns (and risk) are lower than investing in the producers. If you are willing to manage the risk, invest in the miners, either directly or via a fund. The advantage of a fund is that you are less exposed to operations problems that plague every miner from time to time.

Having said all the foregoing, keep in mind that this entire discussion hinges upon the price of gold continuing to track the US dollar. The strong correlation is only partly due to investors running to gold as a hedge against US public debt, which is helping to devalue their currency. This situation can change, and quickly, so act cautiously with your money.