Don’t be surprised if you find some investors breathing a sigh of relief that they opted to invest in gold, while others say that they were rudely shocked by the outcome. Chances are that the earlier bunch would have invested in Gold ETFs* and the rest, in Gold Equity Funds*.
This month (October 1-27, 208), the Sensex slipped by nearly 30%. During this period, Gold ETFs (as a category average) posted -12% while the gold equity funds fell much harder. DSP Merrill Lynch World Gold Fund fell by 45% and the AIG World Gold Fund, -38%. This was even greater than the average fall of diversified equity funds (-30%).
What investors have failed to realise is that the two products (ETFs and gold equity funds) are inherently very different, hence so is their risk and return capability.
Gold stocks can provide much more leverage to the rising gold price than gold itself. So in boom times, such a gold equity fund can deliver impressively - much, much higher than an ETF. But, it also carries company-specific and industry-related risks. For instance, risks related to exploration, depletion of reserves, rising production costs, labour problems, political risks (depending on which country the mines are located).
And this year, all these risks have become a reality. Higher raw material and energy costs this year raised the overall cost of production. Naturally this squeezed their profit margins. On top of it, the global equity turmoil and fears of a recession has also hit the entire equity market, including these stocks. And, if that was not enough, the gold price has not exactly been shooting through the roof. Last week, the price of gold fell below $700 per ounce for the first time in more than a year. As a result, many mining stocks on Wall Street hit fresh 52-week lows.
Newmont Mining Corp., the world's second-largest gold miner, last month stated that cost pressures were constraining the development of one of its projects. Reuters reported that this week, its 3rd quarter profits fell just over 50%, hurt by a decline in gold and copper shipment volumes and higher production costs. The stock, which was trading at $57.55 on January 15, fell to $21.40 this week.
It’s only natural that gold funds will be susceptible to the carnage in the equity markets. While ETFs basically only react to the price of gold. That would explain the difference in performance.
* Gold ETF: Gold Exchange Traded Fund
* Gold Equity Funds are those that invest in the stocks of gold mining companies