HardAssetsInvestor

Written by Brad Zigler  |

November 08, 2009

Holiday Shopping Tips For Gold Stocks

Details

Why did positive earnings in gold stocks lead to falling prices? And how can investors play the space intelligently?

• Good earnings = drop in prices?
• Alpha and beta don't tell the whole story
• Running MPT against gold prices—by the numbers

You'd think last month's earnings releases would have given a boost to gold stocks, since four of the five components of the NYSE Arca Gold Miners Index (GDM) reporting posted positive results. Yet, going into the last week of October, miners' stock prices slumped, only to emerge at the end even lower.

Of course, you could have said virtually the same thing about gold itself, but stock losses were tenfold the slippage in bullion. The exchange-traded fund tracking the miners' index—the Market Vectors Gold Miners ETF (NYSE Arca: GDX)—gave up 9.3 percent last week, while the value of the metal-holding SPDR Gold Shares Trust (NYSE Arca: GLD) eased only 0.9 percent.

So why should good news produce such bad results?

Well, to a certain extent, there's truth behind the old adage "buy on the rumor, sell on the fact." There were whispers on the Street—some good, some not—about the miners' numbers.

Agnico-Eagle Mines Ltd. (NYSE: AEM), for example, was expected to put up per-share earnings of 20 cents for its third quarter; before its earnings report, the company's stock traded above $68. Analysts then started talking up a 19-cent figure. When the company posted an 11-cent loss, however, traders marked down Agnico's shares by more than $15.

Disappointment with poor financial results is understandable, but even the miners' good news went unrewarded. Newmont Mining Corp. (NYSE: NEM) blew the doors off analysts' earnings guesses, taking in 79 cents a share after the sell side forecasted earnings of only 57 cents. Newmont's price reaction? Shares slumped nearly $2.00 before settling halfway up the $43 handle.

A similar scene played out when Barrick Gold Corp. (NYSE: ABX) announced a 54-cent-per-share operating profit. The Street had been eyeing a 47-cent profit before hedging charges, and rewarded company shareholders with a 3 percent haircut.

Likewise, Gold Fields Ltd. (NYSE: GFI) and Eldorado Gold Corp. (NYSE: EGO) both turned in results that met or exceeded Street expectations, only to find sellers anxious to work their share prices lower.

But rumors don't tell the whole story.

Gold Stocks: The Hybrid Investment

The important thing to remember about gold stocks is that they represent hybrid investments. Like any equity, a portion of their returns will reflect traders' sentiments about the issuers' financial prospects, as well as its management team, the general equity market conditions and other idiosyncratic factors. The rest can be attributed to the market's disposition toward gold. Therefore, gold miners in essence serve two masters: the gold market and the stock market.

In the aggregate, 54 percent of the returns chalked up by gold stocks is "passive"; that is, directly ascribable to gold. Of course, the influence of gold upon individual issues varies, but that variance is vitally important in shaping investor expectations.

Gold Miners Index Component Three-Year Relative Share Price Performance

When selecting stocks, investors often look at an issue's MPT (modern portfolio theory) statistics, such as beta and alpha. Beta measures the variance in a stock's price history relative to a market benchmark; simply put, beta tells an investor how volatile that stock's price trajectory is likely to be. Alpha, on the other hand, represents the stock's return in excess of the market and of the risk-free yield on Treasury securities; alpha informs the investor how much excess return—positive or negative—has resulted from that stock's volatility differential in the past.

Investors can often find MPT statistics for individual stocks published by market newsletters or on Web-based financial platforms. Investors should know, however, that they're not getting the whole story about gold miners' risk from these figures.