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Gold Mining Stocks Offer Glittering Dividends

By Ari Charney on November 21, 2011

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Some gold mining companies are hoping to garner attention from those investors who seek a hedge against inflation along with additional yield. But even attractive dividend yields don’t necessarily make gold shares appropriate core holdings for conservative, income-oriented investors.

While gold miners have historically enjoyed their status as a hedge against inflation, that status has faded in recent years. In the past year, however, miners such as Eldorado Gold Corp (NYSE: EGO) and Newmont Mining (NYSE: NEM) have sought to recapture investors’ attention by opportunistically linking their dividends to the price of the yellow metal itself.

Meanwhile, other miners are translating their record profits into record dividend payouts. In fact, the top gold producers, those that mine in excess of 400,000 ounces per year, are expected to pay investors dividends totaling nearly $2 billion by year end. That’s a noteworthy shift for an industry that is traditionally parsimonious with its dividend payouts, preferring instead to reinvest earnings in exploration and development.

Gold Mining Shares Have Lagged Gold in Recent Years

The impetus for this trend may be due in part to waning interest from investors due to gold shares’ lackluster performance in recent years relative to the yellow metal. While the AMEX Gold BUGS Index (NYSE: ^HUI), which tracks 16 gold mining companies, outperformed gold by a little more than five percentage points annualized since the inception of gold’s bull run in 2002, its relative performance has been dismal over more recent short-term time periods.

Although gold miners often led the yellow metal higher in the past, that relationship changed once exchange-traded funds (ETFs) such as SPDR Gold Shares (NYSE: GLD) offered investors easier access to a pure play on the yellow metal. Since SPDR Gold launched in November 2004, gold miners have lagged gold’s performance by roughly 7 percentage points per year. That disparity has increased further over shorter-term time periods. Over the trailing five years, for instance, gold shares lagged the yellow metal by 10.2 percent annualized. And year to date through the end of October, gold shares lagged the yellow metal by 21.5 percentage points.

Gold Miners Are Leveraged to the Yellow Metal, but the Market Hasn’t Noticed

Long-term precious metals investors have often lamented this shift in leadership, as gold shares should eventually benefit from being leveraged to the underlying metal when gold is in a bull market. That’s because as the price of gold rises past miners’ cost of production, miners’ profits actually increase at a faster rate than the returns investors enjoy on the underlying metal.

But the broader market’s downturns have largely kept mining company shareholders from experiencing the benefit of this leveraged effect. After all, gold shares are still subject to the vagaries of the overall stock market no matter how well the underlying metal may perform. Indeed, as mining shares declined in sympathy with the market during recent downturns, investors instead turned to gold ETFs as a safe haven from the travails of equities.

Gold Miners Are Far More Volatile than Typical Dividend Payers

Even as gold receives attention as both a safe haven and an inflation hedge, inflation and deflation are still battling for economic supremacy. One of the consequences of this struggle is that the U.S. Federal Reserve’s interest rate policy has made it very difficult for income-oriented investors to find a safe, reliable yield. But gold shares are far more volatile than typical dividend-paying stocks.

Vanguard Precious Metals (VGPMX), which earned Morningstar’s “Gold” rating, yields 4.7 percent and produces enviable returns with average risk relative to its category peers. But when measured against the S&P 500, the fund’s standard deviation of returns, a key metric of volatility, is nearly double that of the large-cap index. So even a relatively conservative precious metals fund is nevertheless significantly more volatile than the market itself.

How Safe and Reliable are Gold Miners’ Dividends?

Beyond that, the profile of the average precious metals investor is starting to skew younger. In addition to being enticed by gold’s strong performance, younger investors have sought refuge in precious metals from both chaos in the equity markets and the potentially inflationary policies of world governments hoping to stave off another global recession. But these younger precious metals investors tend to be wary of a buy-and-hold approach to investing, which could contribute to incremental volatility among gold shares.

And a gold miner’s dividend stream could be difficult to maintain if the speculators who pile into gold during its hyperbolic ascents subsequently abandon the yellow metal to raise cash during downturns. During the market’s crash in late 2008, gold descended just as precipitously as stocks themselves.

For that reason, industry veterans still take a more conservative view of dividends. In an interview with Mining Weekly, Nick Holland, CEO of gold major Gold Fields (NYSE: GFI) reiterated his stance against a quarterly dividend payout arguing that dividends should be based solely on earnings. Other mining companies have expressed similarly cagey sentiments regarding their dividend policies, noting that investing in projects or paying down debt are a higher priority than increasing their payouts.

Still, the price of gold shares could be buoyed in the near term by miners’ newfound attention to dividends. Institutional investors have increased their holdings in those miners that have boosted their dividends. Other investors, such as Greenlight Capital’s legendary hedge fund manager David Einhorn, are betting that undervalued gold shares will close their performance gap with the yellow metal.

And while gold mining shares may not be suitable as a core holding for most investors, a modest five percent allocation to precious metals stocks could provide investors some comfort against global economic headwinds.

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