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A Good Reason for the Underperformance of Gold Mining Shares Relative to Gold: It's Spelled O-I-L

By Claude Biava

February 24, 2008

The thesis offered here, that rising Oil prices by sharply raising costs of Gold production are, and have been, the primary reason responsible for the under performance of Gold mining shares in general, and of junior stocks in particular, is strongly supported by the following combination of charts (courtesy of Stockcharts.com). In the HUI chart, it can be easily observed that the two-year period 2001-2002, the only period when Gold stocks showed a grandiose out performance relative to Gold, coincided with the final decline of oil prices and their initial weak recovery. As soon as the rise of Oil prices became sustained in 2003, the under performance of Gold shares began and kept worsening to the present day. It is striking to see how closely the HUI/Gold ratio tracks the HUI/Oil ratio. It should come as no surprise that the under performance of Gold shares is now at its worst as Oil prices reach the all time high price of $100/barrel. This is reality, not abstract risk aversion!

If the thesis offered here is correct, what can investors interested in big or small mining shares look for in the near future in order to expect a better performance of these shares?. The answer is: conditions similar to those seen in the 2001-2002 period, namely a more severe economic recession than now expected causing on one hand a retreat of oil prices and on the other more drastic monetary easing by the Fed which will support still higher Gold prices. A combination of such circumstances might do the trick, but then won't we all have to be careful about what we wish for; we just may get it?

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