The stock market is off to a historically bad start to the year, the Fed is rethinking its interest rate hike schedule, European banks are hitting multi-year lows, and the dollar and 10-year Treasury yield are lower.
This is the perfect recipe for gold buying, and that's exactly what we've seen on Thursday. The price of goldGLDIAU is up about 4.3%, and the frenzy shows no signs of stopping soon. (Also read: Why Are Gold Prices Rising Today? )
The rise in the price of gold has also sparked a major spike in gold mining stocks. This correlation makes sense to those with a deep understanding of the nature of gold investing, but many are relatively uninformed. For those looking to add mining stocks to your portfolio to ride this wave of gold, we decided to explore why and when gold prices and mining stocks make big gains.
Uncertainty is Key
The most important factor that influences gold prices is the level of confidence or uncertainty in the market. The things that I mentioned above have weakened investor confidence and have people looking towards commodities, especially gold.
The fact that gold is an actual physical thing that we can see and hold on to gives it a certain level of value protection. Paper currencies, especially in developing countries, are susceptible to hyper-inflation, and stocks can go up and down like an uncontrollable roller coaster. Gold is more certain, and it is because of this that investors look to it during times of uncertainty.
This is the general theory about gold prices. A few smaller, related factors influence gold prices too. A lower dollar means that holders of other currencies can buy gold at cheaper costs. Lower yields mean less incentive for investors to buy bonds, and they may move to gold instead.
Mining Stocks Move With Prices
It makes sense that mining stocks would move with the price of gold. Of course, nobody is flocking to the fields to build new mines right now. Gold mines can take up to 10 years from initial discovery to actual production.
Instead, these gold miners are able to sell their raw material at a higher price. Naturally, this leads to increased revenue and higher profits.
Gold mining is an extremely volatile business. Miners operate with an incredible amount of fixed costs. The actual operation of the mines requires extremely expensive machinery and materials. On top of this, it's not like gold changes from company to company. Every miner is offering the same product and must deal with the same costs.
Therefore, we often see mining stocks outperform gold when it is gaining. Just look at today's action: gold is up about 4.3% but the mining ETFs, GDX and GDXJ , are up about 6.8% and 8%, respectively. Miners, like most companies, try to operate at a profitable level all the time, and sharp increases in gold prices mean extra profits. Extra profits mean higher earnings and better stock performance.
While it certainly isn't time to panic, the uncertainty in the domestic and global economies is probably not going to go away anytime soon. It's reasonable to assume that gold will maintain this strong position and mining stocks will continue to perform well.