Gold or gold stocks? It depends on your confidence in the price

David Berman
Friday, August 6, 2010 7:58 PM

Why invest in commodity stocks when you can invest in the commodities themselves?

Recently, commodities have been the best way to go, with returns that make stock ownership look like a waste of time (well, relatively speaking). The ishares S&P/TSX Global Gold fund, which represents a basket of Canadian and U.S. gold producers, has risen 16 per cent over the past year and 32 per cent over the past three years.

Those are handsome returns, no doubt, but they pale next to the returns of actual bullion. Gold itself (as represented by the SPDR Gold Shares fund), has risen 25 per cent over the past year and 77 per cent over the past three years – or about double the return from stocks.

The trend is similar with the energy sector. A basket of energy producers, as represented by the iShares S&P/TSX Capped Energy fund, has risen 9 per cent over the past year and fallen 9 per cent over the past three years. But oil has done far better, rising 13 per cent over the past year and nearly 11 per cent over the past three years.

What’s going on here? Stocks represent a bet on future earnings, which implies that equity investors are taking a far more cautious view on commodity prices. Gold has been trading hands recently at about $1,200 (U.S.) an ounce, which is close to a record high and a three-fold increase in five years.

The reasons for the spike – mostly to do with high government deficits and concerns about the health of the euro and the U.S. dollar – might be sound. But equity investors appear to be skeptical that the rally will continue, and are less willing to drive up share prices at the same pace as the underlying commodity. Indeed, Stephen Walker, an analyst at RBC Dominion Securities, believes that the price of gold will fizzle to $1,000 an ounce by 2013.

So what you have here are two different approaches, depending upon your confidence in the price of gold. If you’re particularly bullish (gold bugs fall into this camp), and believe that the current $1,200 an ounce is just the start of things, then investing directly in the commodity sounds like the best way to profit if things go your way.

On the other hand, equities are better suited to more cautious investors. If the price of gold flat-lines, investors won’t make a penny if they hold gold. But they will do just fine if they hold gold stocks.