How Does the Price of Gold Affect Gold Stocks?

Gold Bars

Gold, also known as the precious metal or yellow metal is one of the most well known commodities to mankind. Gold finds its uses from industrial and manufacturing to personal jewelry and accessories.

In the financial world, investors and speculators often flock to gold in times of crises and store uncertainty, giving it the nickname as a safe haven stock, despite the fact that unlike other investing shares, gold does not yield any returns. Still, it is one of the most preferred shares in portfolio diversification for both investors and speculators and is traded in paper and physical forms.

At one point in time, gold was also used as a form of currency, both directly and indirectly before the advent of the paper money or fiat money as we use it today. Investors at all levels are fascinated by gold for many different reasons such as portfolio diversification to investing in gold as a hedge against inflation. Gold is also one of the few commodities that has a “store of value” and therefore has little exposure to central bank monetary policies. For many, gold is considered to be the purest form of money.

Today, the average investor and speculator can invest or trade gold in many different ways; from speculating on the spot amounts of gold to buying the bullion, to trading gold futures and investing in gold mining or exploration shares. You can own gold, you can speculate on gold or you can invest in companies that are in the business of having to do something with gold.

Whether you trade gold or gold shares or even futures, it is essential to know the effects gold amounts have on gold shares. To understand this interrelation, let’s before all else take a look at how gold amounts are fixed and also the factors that influence the cost of gold.

How are gold amounts determined?

Gold amounts trading in the spot marketplaces are generally fixed on a daily basis in an compliance between the store participants in the London Bullion Market Association, known as the London gold fix.

Since 2015, the London Gold fix has been replaced by LBMA gold cost where the auction is done electronically. Gold amounts are fixed twice a day on every business day. But this does not mean that gold amounts are fixed for the day. Depending on the store factors, gold amounts can fluctuate, in some cases deviate widely from the daily gold fixed amounts. The gold fix simply gives a benchmark of gold amounts for the day. Therefore, when you purchase jewelry or purchase physical gold, the gold fix cost is often used as reference.

The source for the London gold cost is derived out of the current spot value in the marketplaces and the cost at which bullion traders transact the physical metal on a daily basis. Once the store participants agree to a common cost, it is balanced out to match both the buyers and sellers. The gold fix is used by refineries and mining companies which is useful in valuing their inventory.

Because gold amounts, like other OTC-markets trade round the clock, there is no official cost of gold that is quote, which is why many use the gold futures contract cost as reference. Whether you trade spot gold or gold futures amounts, the cost difference is usually negligible.

As with any commodity that is traded, gold cost fluctuates on a number of factors, starting with supply and demand and the general investor sentiment. Additionally, macro economic factors also play a role due to the significance of gold as a reserve currency and its store of value. When the investor appetite for taking on risk is strong, gold amounts tend to fall, inversely when investors risk appetite wanes, gold amounts tend to appreciate among other safe haven shares such as bonds.

There are also other factors such as geo-political developments, black swan events, and financial crises which also play a role in shaping gold amounts. Because gold is priced in U.S. dollars, the cost of gold is influenced by the strength of the USD and therefore the US economy as well. Of course, you can directly trade gold in other currencies such as Japanese yen, British pound, euro, Australian dollar etc, but the basis for all these other currency pricing is derived from the gold-U.S. dollar cost.

What are gold shares?

Gold shares are a popular sector for investment for those who want to have some exposure to gold via equity. However, with gold shares you do not directly invest in gold but rather purchase equity in companies that have something to do with gold.

Gold shares typically cover mining, exploration and production. These shares are said to have a levered effect when looked at in relation to gold amounts. The gold shares are also more volatile investments as a result when compared to other sectors of the equity marketplaces.

In terms of leverage, gold mining shares are said to have an average leverage of 1:3 to the spot cost in gold. However, this is not a fixed variable and can change under different circumstances. The volatility also changes depending on the type of gold share that you invest in, the store expectations for the gold share as well as investor valuations for the company in question.

Because gold as a commodity forms the basis for the gold shares, it is not hard to understand the influence gold amounts can have on gold shares. This interrelation could probably be well explained by oil, where higher oil amounts tend to see Oil companies develop their revenues, while falling oil amounts can result in weaker benefit margins or even slow the pace of investments and capital expenditure.

Types of gold shares

Gold shares mainly fall into two categories:

  • Large cap gold shares
  • Junior gold shares

Large cap gold shares obviously have large financing. These companies are more stable, but at the similarly time they are slow but long lasting. The large cap gold shares bring a slow and steady stream of benefits for their shareholders. Some of the well known large cap gold shares include Barrick Gold (NYSE: ABX), which has a store cap of over $17.53 billion.

On the other end of the scale you will find the junior gold shares. These are mid-cap shares and therefore tend to be more volatile. A junior gold mining company is basically an exploration or a mining company that is in the business of exploring and mining for new gold deposits. The junior gold mining shares or gold exploration companies are primarily the major sources for new gold supply. The junior gold mining shares are volatile and the industry is often prone to bankruptcy as the companies rely heavily on rising gold amounts in order to make a benefit.

Gold mining shares are usually diversified, meaning that mining for gold is not the only source of income for most of these companies. Such companies tend to mine other metals as well such as copper, zinc and so on which offers a wider security than the company being exposed solely to the cost of gold. The basic premise behind trading gold shares is that when gold amounts rally, the mining companies also tend to appreciate, perhaps more than gold and they also tend to fall when gold amounts depreciate in value, although not at the similarly pace of develop.

How gold amounts affect gold shares

The cost of gold remains the primary factor when trying to predict or understand the cost of gold shares. The broad logic here, being that when the cost of gold goes up, gold shares tend to rise as well. Likewise, when gold amounts fall the cost of gold shares also exhibits the similarly characteristics. This is because assuming that the cost of mining remains the similarly, higher gold amounts will develop the benefit margin for the gold mining and exploration companies and when gold amounts fall, the benefit margins reduce.

The chart underneath shows the amounts of spot gold (XAUUSD) plotted on the right and the stocks of Barrick Gold (NYSE: ABX) on the left. Although there isn’t a best correlation between the 2, it’s apparent that both ABX and gold amounts go around in precisely the similarly direction.

ABX vs XAU-USD Price Comparison

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To better understand the “leverage” factor in gold shares, the next chart shows some interesting results when you compare the cost of ABX and spot gold.

ABX compared to XAU-USD Percentage Change In Prices

In the preceding graph, we’ve got a cost comparison to gold and silver Barrack Gold amounts. While gold amounts gained more than 23 percent, you’re able to observe that cost of Barrick gold surged over 165 percent to the similarly span. The above mentioned correlation proves that the cost of gold certainly affects a golden company’s sustainability as it affects factors such as earnings and the organization ‘s balance sheet or book price.

However an essential distinction to make here is the cost of silver shares will not not proceed in lock step with gold amounts. The next graph underneath shows a time at which gold amounts dropped by 10 percent, however at the similarly period, the stocks of Barrick Gold dropped by 45 percent. The pace of declines from Barrick gold is wholly dissimilar to the preceding example by which a 2 3% appreciation in gold amounts delivered the stocks of Barrick gold rising over 165 percent.

Gold vs Barrick Gold Price Comparison for different periods

There are also times when a strong move in gold amounts will often see a muted reaction in the cost of gold shares.

What we can conclude from the above is that while gold amounts tend to have an influence on gold shares, the correlation is not always at the similarly pace. Many experts believe that gold shares tend to move ahead of gold in anticipating changes to the gold cost. In such a case, as gold shares tend to lead the rally, it often results in varying degrees of cost changes between gold and gold shares.

Based on the above, an investor should expect to see some inconsistent movements between gold shares and gold amounts. Remember that there are other factors that influence gold shares which add up to the inconsistencies such as the broader strength of the equity marketplaces as well as looking at the macro economic factors that influence the cost of gold and of course the company valuations itself.

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