Why gold bugs no longer love gold miners

STRIKING gold is generally considered a slice of good luck. Owning it, however, is a sign that you fear the worst. Some people buy the yellow stuff because they think it looks pretty, to be sure. But the quintessential gold bug is an investor who expects every form of paper wealth to collapse, along with civilisation itself.

Gold is not like other commodities. The demand for iron ore depends on down-to-earth things, such as how many steel girders Chinese builders are using. The demand for gold depends on airier considerations, such as whether you think Barack Obama is the Anti-Christ.

Not all gold investors stockpile guns and tinned food in remote cabins, of course. Nor are they all fans of Glenn Beck, an American pundit who preaches doom and urges his listeners to buy gold. But most agree that the world is a scary place. The euro zone is tottering, America’s deficit is alarming and inflation is looming, they reckon. Such fears have ramped the price of gold up to an incredible $1,545 a troy ounce, up almost sixfold in a decade.

Yet gold miners’ shares have failed to keep pace (see chart). This is new. Gold and gold-mining shares used to rise and fall in lockstep. Over the past five years, however, the price of gold has trebled while the value of gold miners has merely doubled. Investors in firms that shift, crush and process rocks are more grounded, it seems, than those who invest in bullion.

As mines age, extracting gold gets harder and costlier. Ores give up less of the metal—average grades have fallen by 30% since 1999 according to GFMS, a consultancy. And ore must be hauled up from ever greater depths. Fuel is pricier. So, too, are labour and equipment, since the global minerals boom has driven up demand for miners and drills. A decade ago the average cost of extracting an ounce of gold from the ground stood at a little over $200. In 2010 it hit $857, says GFMS—though this figure depends in part on the gold price. When gold was $200 an ounce, nuggets that cost $800 to extract stayed buried.

Finding new seams to replace depleted ones is becoming harder. Metals Economics Group, a mining consultancy, estimates that in 2002 gold miners spent $500m on exploration. By 2008 they were spending $3 billion but finding much less. All the easy gold has been mined already.

The big gold-mining firms have turned to acquisitions to boost their reserves. Last year Australia’s Newcrest bought an Aussie rival, Lihir Gold, for $8.7 billion. By value, 31% of the mining deals last year involved gold, according to the consulting arm of PwC. Merged firms seek to cut costs, and often end up spending less on exploration than they did separately. That makes it even less likely that they will find much more gold.

The world’s miners dug up 2,689 tonnes of gold last year. Granted, that was a record. But, despite the huge surge in investment, it was only a few flakes more than the total output a decade ago.

Investing in gold miners carries risks unrelated to the price of the metal. Mergers can flop. As readily recoverable reserves dwindle in stable places such as North America and Australia, miners are forced to operate in more troublesome ones, such as Latin America and Africa. Huge investments can yield disappointing returns if promising mines turn out to contain less glitter than predicted.

Gold bugs, by definition, bet that the price of gold will go up and up. Miners sometimes do the opposite. Many hedged their wares, selling gold forward to ensure smooth cash flows and to raise money to dig more mines. This may have seemed prudent at the time. But it repelled gold bugs and, as the gold price rose ever higher, it hurt the miners’ profits, too. Barrick Gold, the world’s biggest gold miner, and AngloGold Ashanti, the third-largest, have both spent billions unwinding hedges over the past couple of years.

Gold bugs are often allergic to other metals. Gold miners are not. Many produce copper, too, since it often sits in the same ore bodies as gold. In April Barrick offered $7.7 billion to trump a Chinese bid for Equinox, an Australian copper miner. The heavy demand in China and short global supply for “red gold” makes Barrick’s move look sensible. But gold bugs hated it. Barrick’s shares fell sharply after the bid was revealed.

Most damaging of all for the marriage between gold bugs and gold miners has been the arrival of a seductive new financial tool. Exchange-traded funds (ETFs), backed by physical gold, offer investors direct exposure to the gold price without any exposure to gold miners themselves. They have become popular: in less than a decade gold ETFs have gone from nothing to holding some 2,200 tonnes of gold—nearly a whole year’s production.

If the world goes to hell, gold bugs will say: “I told you so.” But if investors ever wake up and notice that the yellow metal is little more useful than tulips, the gold bugs will be burned. The miners, less so.