Many clients have asked if PWL has considered investing some of their assets in gold bullion. We still believe that investing in gold is not an “investment”, but rather, a “speculation”. Gold does not pay dividends, interest, or income in the same way we expect stocks, bonds, and real estate to do.
That being said, most PWL investors are exposed indirectly to bullion through gold mining companies held in their Canadian equity holdings. As of November 30th, 2010, approximately 13% of the iShares S&P/TSX 60 ETF (XIU) is comprised of companies held within the S&P/TSX Global Gold Index. These mining companies’ stock prices can be inherently more volatile than holding the gold bullion directly or through an ETF that holds the precious metal, such as the iShares Gold Trust (IAU). The reason for this increased volatility is due to many company specific factors, but the operating leverage of mining companies can be a main contributing risk factor. For a simplified example of this operating leverage, suppose gold is trading at $1,400 per ounce. Assume a mining company has operating costs of $600 per ounce to extract the gold, resulting in a profit of $800 per ounce. Now what would happen to the company’s stock price if the price of gold were to increase by 20%, or worse, decrease by 20%?
As can be seen in the table above, when gold prices are increasing, gold mining companies have the ability to earn returns in excess of the return on gold, but they also have more downside risk if the price of gold declines.
A common argument for not using gold mining companies for indirect exposure to gold bullion is that these companies hedge away some of their gold exposure, thereby not benefiting fully if the price of gold were to increase. On the contrary, examining the latest quarterly reports of just two of the largest gold mining holdings in the iShares S&P/TSX 60 ETF (XIU), as of November 30th, 2010 (Barrick Gold Corp (ABX) with a 4.74% weighting, and Goldcorp Inc (G) with a 3.12% weighting), reveals that both companies are 100% unhedged to the fluctuations in the price of gold.
It could be argued that non-speculating Canadian investors should not be considering whether they should buy gold, but whether they should reduce their exposure to the sectors that these Canadian mining companies operate within, most notably, the materials sector. By diversifying PWL portfolio assets outside of Canada and into the U.S. and International markets, we are able to significantly reduce materials sector exposure for our clients.