From gold to Bitcoin, why can't "mining" ever outpace the "ore" itself

Whenever the price of gold rises, many people tend to think that this will benefit gold mining stocks, but in reality, this may be a misconception. Gold mining stocks have performed much worse than physical gold over the past 15 years.

Gold Rises, But Gold Mining Stocks May Not Follow Suit

According to Koyfin data, since November 2009, the ETF tracking physical gold -- SPDR Gold Shares (GLD) has accumulated a whopping 99% increase.

In contrast, the ETF tracking the three major gold mining giants (Newmont, Agnico Eagle, and Barrick Gold) -- VanEck Gold Miners (GDX), has declined by 17.9% during the same period.

Another ETF tracking small-cap gold mining stocks -- VanEck Junior Gold Miners (GDXJ), has declined by 40% during the same period.

This also means that the performance of gold mining stocks has lagged far behind that of gold, giving investors a warning: while gold may serve as a certain "store of value," it does not mean that gold mining stocks can also bring returns.

Moreover, in reality, the overall performance of gold is not very impressive. According to data from Macrotrends, adjusted for inflation, the price of gold has accumulated less than 300% in the past 100 years, with an annualized real return rate of only about 1.34%.

Gold mining stocks cannot even outperform a 1% annualized return, which is truly surprising, considering that gold mining companies typically operate with leverage.

The Operating Leverage Effect of Gold Producers

In theory, gold mining companies' stock prices exhibit leverage when facing fluctuations in gold prices, meaning that the stock prices of gold mining companies often fluctuate more than the price of gold itself, and this leverage mainly comes from the operating model of gold mining companies.

Generally, the operating costs of gold mining companies are divided into fixed costs and variable costs. Fixed costs (such as equipment, management fees, etc.) do not change with gold production, while variable costs (such as labor, fuel, etc.) are directly proportional to gold production. When the price of gold rises, the fixed costs of gold mining companies are spread out, and the profit margin will increase significantly, thereby amplifying the impact of gold price changes on company profits. Conversely, when the gold price falls, the profits of gold mining companies will also plummet. The following is a simplified example to illustrate this point.

Suppose a gold mining producer can produce 100,000 ounces of gold per year, with a cost of $1,500 per ounce, and its total operating cost is $30 million per year. If the current spot gold price is $2,300, this mining company can generate annual revenue of $230 million from selling gold, with total costs of $150 million, resulting in a gross profit of $80 million. After deducting the $30 million operating cost, the mining company has $50 million in pre-tax profit If the gold price falls by 20% to $1840 per ounce, you will find that the miner's profit basically disappears: his gross profit will decrease to $34 million, but the pre-tax profit will only be $4 million. In other words, with a 20% drop in the base gold price, his profit decreased by 92%.

Conversely, if the gold price rises by 20% to $2760 per ounce, the pre-tax profit of the gold mining company almost doubles, reaching $96 million.

In these two scenarios, with the gold price only rising/falling by 20%, the profit of the gold mining company fluctuates by over 90%. This non-linear growth in profit is a manifestation of the leverage effect of mining companies. Unfortunately, this leverage effect does not linearly transmit to the stock of gold mining companies, meaning that even if the company's earnings fluctuate by 90% due to changes in gold prices, the stock price may not necessarily fluctuate by 90%.

Why did the operating leverage of gold mining companies fail?

Even the stock performance of gold mining giants like Newmont and Barrick Gold has been negative over the past 20 years, while the price of gold has nearly quintupled during the same period.

Clearly, the operating leverage of these gold mining companies has failed. What are the reasons behind this? Some analysts point out:

Firstly, poor management by gold mining companies is one of the influencing factors, such as excessive executive compensation and improper capital allocation. Over the years, Barrick Gold's chairman John Thornton has been criticized for excessive compensation.

Secondly, geopolitical turmoil and onerous taxes in mining areas are also key factors. For example, in 2019, the Tanzanian government demanded $190 billion in taxes from Barrick's subsidiary Acacia Mining, which was later settled for $3 billion.

Over the past few decades, numerous examples have shown that besides understanding reserves and production, gold mining companies also need to face more scrutiny. Operational management and geopolitical risks are important factors, and internal and external factors often prevent miners from fully leveraging their operations. These factors have led to mining stocks underperforming compared to the price of gold.

Interestingly, apart from gold mining stocks, the phenomenon of "mining can't keep up with mining" has also appeared in the Bitcoin field.

The Bitcoin miner ETF - Valkyrie Bitcoin Miners (WGMI), launched in February 2022, has cumulatively declined by 12%, while Bitcoin during the same period has risen by 29%.

This once again proves that achieving the theoretically expected leverage is actually quite difficult