Over the past year, gold prices have jumped by about a third, from around $900/ounce to over $1,200/ounce. And while the ETFs that track gold bullion and gold miners are showing gains for the past 12 months, the gains are not keeping up with the market.  The SPDR Gold Trust ETF (NYSE:GLD) is up about 24% in the past year, while the Market Vectors Gold Miners ETF (NYSE:GDX) is up about 15%, and the Market Vectors Junior Gold Miners is up about 7%. Among the miners, junior miners Gold Reserve Inc. (AMEX:GRZ) and DRDGold Ltd. (NASDAQ:DROOY) has performed the worst, down nearly 58% and 57%, respectively. Among large miners, Rio Tinto plc (NYSE:RTP) and Kinross Gold Corp. (NYSE:KGC) are down about 28% and Yamana Gold, Inc. (NYSE:AUY) is down about 26%. The closest any miner is to its 52-week high is down about 10%.

SPDR Gold Trust, a major buyer of gold bullion, should be performing best and it is. Gold is still gold, and having a basement full of the stuff is just good insurance, especially as markets continue to worry about Europe and the slow-moving global economic recovery.

The two mining ETFs are actually performing better than any of the individual stocks in their holdings. That is not easy to explain other than to say that investors’ expectations may be higher than the mining companies ability to perform. Adding weight for the price of gold keeps these ETFs higher than expected.

For the big miners, their ability to keep production costs is the key to profitability. Another important factor in profitability is good currency hedging. Any bets on the euro have certainly cost these companies money in the current quarter. Because gold prices have risen steadily for nearly 10 years, most gold miners no longer hedge their production.

Kinross reported a cost per ounce of $461, up 10% from a year ago. The company also expects costs of $460-$490/ounce for the full year. The company’s average realized price was $1,065/ounce.

Among the junior miners, DRDGold reported cash operating costs of 221,400 South African Rand/kilo. At at an approximate conversion rate of 8 Rand/dollar and 35.2 ounces/kilo, that comes to an operating cost of about $786/ounce. The company’s average realized price, again converting from Rand, was about $960/ounce. The comparison with Kinross’s costs and prices says a lot about the very tough environment a junior miner faces.

Mining is a high-cost, capital-intensive business and the big differential between bullion prices and mining shares should not come as a surprise. The really bad news for miners will come when gold prices start to decline, which some analysts think could happen by the end of the year.

One sign to watch for is the miners’ hedging activity. If the large miners begin to hedge their future production that is a sure sign that they believe that prices are headed down.  Interest rates are also being kept artificially very low as he economic recovery still has risks.  The price of gold also depends on how well the global economic recovery proceeds, and especially on growth in China. If the Chinese economy continues to grow without added inflation and overheating, gold prices could fall sharply.

Gold miners face some hard choices in the next few months, and the junior miners are in a particularly difficult spot.  Many of their shares are testament to that notion.

Paul Ausick

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