When will gold stocks catch up to bullion?

What will it take for gold stocks to finally catch up to bullion? According to a new report from CIBC World Markets, the price of the yellow metal needs to rise faster than cost inflation for miners.

Investors continue to be disappointed by the performance of gold equities given the strong gains for gold itself during the past four years.

A long list of culprits are often cited as to blame, including competition from gold bullion ETFs, weak operating results relative to expectations, and a lacklustre M&A environment. Rising capital and operational costs, government action creating uncertainty with regards to permitting and participation in projects, and lower trading volumes prompting liquidity concerns are among others.

CIBC analyst Barry Cooper agrees that many of these factors have contributed to the negative sentiment towards gold stocks. However, he suggested other reasons are likely to blame for the downturn in trading multiples for the group.

Mr. Cooper noted that oil and gas companies are also underperforming their respective commodities. He thinks this trend may be partly linked to perceptions of commodity cycles.

“While the oil sector tends to have a cycle well-matched with the perception of global economic health, the gold sector cycle tends to be less defined, as arguments can be made that bullion is both cyclical and counter cyclical,” the analyst said. “In the absence of a long historical pattern for comparison, gold equities may mimic other groups, at least temporarily.”

Other sectors have fallen victim to multiple compression since the financial crisis of 2008-2009. Mr. Cooper found that earnings multiples for utilities, telecom and technology stocks peaked in late 2007 or early 2008. Yet despite the declines in share prices for these groups during the crisis, multiples still declined to new lows.

“The world in essence changed, with the financial setback establishing a higher level of risk and a correspondingly lower valuation ascribed to equity risk,” the analyst said. “It only makes sense then that gold stocks participated in this global resetting of value.”

Mr. Cooper believes the multiple collapse in gold stocks is likely permanent, or it will remain compresses until gold prices rise faster than the rate of mining inflation.

“We think that, aside from all of the factors we have discussed that limit the upside to gold shares, companies will need to change the way they look at the business in order to attract a broader audience that can allocate investment dollars to those places where returns are highest,” he said.

“The struggle between investors’ and companies’ strategies is likely to continue if for no other reason than each player’s timeframe for return is vastly different.”