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Maxwell Gold

Director Investment Strategy

Investment Insights

Another golden rule: gold miners gold

September 2016

Summary

Unlike gold, historically gold miners have served as ineffective


hedges against tail event risk and large market drawdowns.

Gold miners offer inefficient sources of portfolio diversification


by further adding equity factor exposure. Historically, they
increased volatility and reduced returns relative to gold.

Cost cutting measures like debt and capital expenditure


reduction have boosted gold mining companies earnings in
the short term but at the expense of long term profitability.

Year-to-date gold mining stocks have surged, with the Philadelphia


Stock Exchange Gold & Silver Index (gold miners) up over 110%
as of September 23rd, setting off a new gold rush in the eyes of
investors. From their perspective holding gold mining equities is
the same as (if not better than) an investment in gold itself. This,
however, is a misconception and overlooks many deficiencies in
holding gold miners as a proxy for gold within portfolio allocations.
Exhibit 1: One of these things is not like the other
Gold Price ($/ounce)
Philadelphia Stock Exchange Gold & Silver Index (XAU)
NYSE Arca Gold BUGS Index (HUI)

500%

Gold miners are a poor proxy for gold allocations because they
depend on industry competition and company specific factors
beyond the gold price. Their valuation is dependent on profitability,
operational costs, financial health, and other company specific risks
while industry outlook and growth prospects dictate investor
sentiment. Many of these factors move independent of fundamental
drivers for the gold market, but come into play for equity investors.
Additionally, mining companies historically have undergone
activities which have limited shareholder participation in the gold
price. Activities including gold hedging programs, cost cutting
measures, high debt financing, disadvantageous mergers &
acquisitions, and dividend cuts (a key rationale to hold equity
investments) have contributed to their underperformance to gold.

A critical investment benefit offered by gold is its role as a hedge


against market turmoil and systemic risk. In this capacity gold has
a proven track record with an average return of 7% during market
drawdowns of more than 10% in the S&P 500 since 1987 (Table 1).

300%
200%

Table 1: Gold miners underperform gold, on average,


during periods of large stock market drawdowns

100%
0%

While gold miners are valid investments, they are an investment in


equity not gold. Investors should view gold miners as distinct from
gold allocations within portfolios in order to benefit from golds
unique investment and risk management characteristics.

Gold miners are not effective risk hedges

400%

1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016

Cumulative Tot al Return (%)

600%

Gold miners look like gold but act like equity

Source: Bloomberg, ETF Securities. Exhibit data from 01/01/93 to 8/31/16. See
important information for further details.

Gold miners have long been viewed as a viable substitute for gold
by US investors. This is partly linked to historical restrictions of
physical gold ownership in the US and limited accessibility to the
market for non-institutions. In recent years, however, markets have
witnessed a visible separation in the performance between the price
of gold and broad gold mining indices (Exhibit 1).
This dislocation is reflective of the challenges facing gold miners
since the 2008 financial crisis separate from the price of gold. It
underpins a critical theme that gold miners, while indirectly linked
to gold through production, are not a pure play on gold.

Date range
8/28/08 - 03/09/09
8/25/87 - 12/04/87*
3/19/02 - 07/23/02
9/29/00 - 04/04/01
7/16/90 - 10/11/90**
7/17/98 - 08/31/98
7/07/11 - 10/03/11
10/09/07 - 03/10/08
8/24/01 - 09/21/01
4/23/10 - 07/02/10
1/14/03 - 03/11/03
6/05/08 - 07/15/08
11/03/15 - 02/11/16
7/20/15 - 08/25/15
Average

Total return during peak to trough drawdown


Gold Miners
S&P 500
Gold
l -23.1%) (
l -47.1%)
10.5% (
8.4%
6.8%
-5.8%
6.8%
-6.4%
8.2%
31.8%
6.8%
4.7%
-0.2%
11.4%
11.5%
4.0%
7.0%

-28.4%
-8.1%
1.9%
-11.8%
-30.4%
-11.8%
9.3%
-0.1%
-1.4%
-13.8%
8.6%
13.6%
-4.9%
-7.2%

-33.5%
-31.5%
-22.7%
-19.2%
-19.2%
-18.4%
-17.9%
-18.4%
-15.6%
-13.8%
-13.3%
-12.7%
-12.0%
-21.1%

Source: Bloomberg, ETF Securities. See important information for further


details.*Price returns for Gold miners & S&P 500. ** Price return for Gold miners.

Past performance is no guarantee of future results.

Of the 14 observations evaluated, gold has posted positive returns


nearly 80% of the time while the gold miner index had positive
returns only 29% of the time. Additionally gold has been the
relative outperformer versus gold miners and beat the index 12 out
of 14 periods of heightened US equity market volatility. Golds
outperformance in the majority of these periods was by a
considerable return differential (14.2% on average).
It appears that gold miners have not acted as effective risk hedges
in most periods compared to gold over three decades. During these
market periods, gold miners have behaved more in line with
equities and lacking golds historic downside protection qualities.

Gold miners are inefficient sources of portfolio


diversification
Another key portfolio benefit of gold lies in its diversification
capabilities. Gold historically has a zero correlation to US equities
and 0.1 correlation to global equities from 01/01/93 to 08/31/16,
making it a true diversifier against equity risk. Gold miners
historically are highly correlated to the price of gold (0.7) over this
same time period, yet lack the same diversification properties for
portfolio allocations inherent to gold. By evaluating simple
stock/bond portfolios, the inefficiency of using gold miners as a
proxy for gold exposure becomes clear.
As highlighted in Exhibit 2, a diversified stock/bond portfolio when
allocated 10% to gold and gold miners respectively, sees the
portfolio with gold yield a higher annualized total return (6.6% vs
6.3%)and considerably lower annualized volatility (8.0% vs 9.5%)
compared to the portfolio with gold miners. Golds efficiency within
a portfolio context is also reflected with its higher Sharpe ratio of
0.49 versus 0.38 for a portfolio utilizing gold miners. A key driver
behind these results lies in gold miners higher correlation to equity
and overall volatility (38%) since 1993 relative to volatility of gold
(16%) as well as US and global equities, 14% and 15% respectively.

Gold miners higher risk contribution is a direct result of its key


drivers (or factors) being rooted in equity risk with movements
closely linked to the market and economic cycle. Gold, however,
stands as a stark contrast as its factors are rooted in drivers not
easily replicable in other investments. Golds factors emanate from
its diversified sources of supply and both cyclical and countercyclical sources of demand.

5 0% Stocks/40% Bonds/10% Gold

10%

9.5%

9%
8%
7%
6%

5 0% Stocks/40% Bonds/10% Gold Miners

6.6%

0.49

50%

8.0%

0.38

40%

6.3%

30%

5%
4%

26.0%

20%

3%
2%

10%

6.7%

1%
0%

0%
Portoflio
Return

Portfolio
Volatility

Risk
Contribution

Sharpe
Ratio

Source: Bloomberg, ETF Securities. Exhibit data from 1/1/93 to 08/31/16. Stocks =
MSCI World Index, Bonds = Barclays US Aggregate Index, Gold = spot price return,
Gold Miners = Philadelphia Stock Exchange Gold & Silver Index. Portfolio return and
volatility are annualized. See important information for further details.

Investment Outlook
Despite golds stellar performance this year, returning 26% as of
September 23rd, gold miners have clearly outperformed, with
broad index returns ranging from 80-100% over the same time
frame. A key driver behind gold miners strong performance has
been profit margin expansion through cost reductions - most
notably capital expenditures and debt - while a stronger gold price
environment this year further boosted gold miners profitability.
In response to declining gold prices in recent years, capital
expenditure has been curtailed extensively 21% drop over the
prior year. While declining capital expenditures translate into lower
costs, thereby improving short term profitability this year, it comes
at the expense to longer term growth prospects by not investing in
new technology, mine exploration, and existing production (Exhibit
3). Another cost which miners have aggressively sought to reduce
has been their excessive debt loads. This has been achieved by
selling non-performing assets, rejecting future capital expenditure,
reducing their workforce and cutting dividends.
While reducing their debt has improved current operating margins
and cash flow, it may come at the expense of future profitability.
Heading into 2017, gold will likely reflect further deterioration in
global economic or political uncertainty quicker than gold miners.
Exhibit 3: Lower capital expenditures may be detrimental
to future profitability for gold miners
1400

All in Sustaining Costs


Capital Expenditures (Capex)

80%

60%
1300
40%

1200

20%

1100

AVERAGE AISC = 1019


1000

0%

900

-20%

800

-40%

Capex % change y -o-y

Looking at another figure, risk contribution, highlights how much


of total portfolio risk, as measured by volatility, is driven by a
particular investment. For a 10% allocation to gold in a diversified
portfolio, gold contributes less than its share to total portfolio risk
(6.7%) while a 10% allocation to gold miners contributes an
outsized 26.0% to total portfolio risk (more than 2x its asset
allocation) making it an inefficient diversifier.

Exhibit 2: The portfolio benefits of gold over gold miners

All in sustaining cost s ($ US)

Turning to gold miners, however, their ability to hedge against


large equity pullbacks is less enticing. The Philadelphia Stock
Exchange Gold & Silver Index, a broad gold mining equity index, on
average has posted a total return of -7.2%, offering limited
downside protection against an average -21.1% drop in US equities.

2011
2012
2013
2014
2015
2016
Source: Metals Focus, ETF Securities. Exhibit data from 1/1/11 to 06/30/16. See
important information for further details.
Past performance is no guarantee of future results.

Important Information
The statements and opinions expressed are those of the author and are as of the date of this report. All information is historical and not indicative of
future results and subject to change. Reader should not assume that an investment in any securities and/or precious metals mentioned was or would
be profitable in the future. This information is not a recommendation to buy or sell. Past performance does not guarantee future results.
The ETFS Silver Trust, ETFS Gold Trust, ETFS Platinum Trust, ETFS Palladium Trust and Precious Metals Basket Trust are not
investment companies registered under the Investment Company Act of 1940 or a commodity pool for purposes of the
Commodity Exchange Act. Shares of the Trusts are not subject to the same regulatory requirements as mutual funds. These
investments are not suitable for all investors. Trusts focusing on a single commodity generally experience greater volatility.
Commodities generally are volatile and are not suitable for all investors. Trusts focusing on a single commodity generally experience
greater volatility. Please refer to the prospectus for complete information regarding all risks associated with the Trusts. Shares in the Trusts are not
FDIC insured and may lose value and have no bank guarantee.
The value of the Shares relates directly to the value of the precious metal held by the Trust and fluctuations in the price could materially adversely
affect investment in the Shares. Several factors may affect the price of precious metals, including:

A change in economic conditions, such as a recession, can adversely affect the price of the precious metal held by the Trust. Some metals
are used in a wide range of industrial applications, and an economic downturn could have a negative impact on its demand and,
consequently, its price and the price of the Shares;
Investors expectations with respect to the rate of inflation;
Currency exchange rates;
interest rates;
Investment and trading activities of hedge funds and commodity funds; and
Global or regional political, economic or financial events and situations. Should there be an increase in the level of hedge activity of the
precious metal held by the trust or producing companies, it could cause a decline in world precious metal prices, adversely affecting the
price of the Shares. Should there be an increase in the level of hedge activity of the precious metal held by the Trusts or producing
companies, it could cause a decline in world precious metal prices, adversely affecting the price of the shares.

Also, should the speculative community take a negative view towards the precious metal held by the Trusts, it could cause a decline in prices,
negatively impacting the price of the shares. There is a risk that part or all of the Trusts physical precious metal could be lost, damaged or stolen.
Failure by the Custodian or Sub-Custodian to exercise due care in the safekeeping of the precious metal held by the Trusts could result in a loss to
the Trusts.
The Trusts will not insure its precious metals and shareholders cannot be assured that the custodian will maintain adequate insurance or any
insurance with respect to the precious metals held by the custodian on behalf of the Trust. Consequently, a loss may be suffered with respect to the
Trusts precious metal that is not covered by insurance.
Commodities generally are volatile and are not suitable for all investors.
Diversification does not ensure a profit nor protect against loss.
Please refer to the prospectus for complete information regarding all risks associated with the Trust.
Investors buy and sell shares on a secondary market (i.e., not directly from Trusts). Only market makers or authorized
participants may trade directly with the Trusts, typically in blocks of 50k to 100k shares.
Definitions: Year over year = the percent change over a full calendar year. All-in sustaining costs (AISC) is a mining cost disclosure framework
focusing on all costs incurred in sustaining production for the complete mining lifecycle, from exploration to closure. The S&P 500 Index is a
capitalization-weighted index of 500 stocks selected by the Standard & Poors Index Committee designed to represent the performance of the
leading industries in the U.S. economy. The Barclays US Aggregate Bond Index (Barclays Agg) is a broad-based flagship benchmark that measures
the investment grade, US dollar-denominated, fixed-rate taxable bond market. The MSCI World Index is a free-float weighted equity index
developed to track developed world markets, and does not include emerging markets. Philadelphia Stock Exchange Gold & Silver Index (XAU) is a
capitalization-weighted index composed of companies involved in the gold or silver mining industry. The NYSE Arca Gold BUGS Index (HUI)is a
modified equal-dollar weighted index of companies involved in major gold mining. Capital expenditure, or Capex, are funds used by a company to
acquire or upgrade physical assets such as property, industrial buildings or equipment. Correlation is a measure of fluctuation between two
variables, cumulative return is the aggregate amount an investment has gained or lost over time, annualized return is amount of money earned by
an investment each year over a given time period, volatility is a measure of dispersion of returns, and the Sharpe ratio indicates the average return
minus the risk-free return divided by the standard deviation of return on an investment. Risk contribution is a step further beyond asset allocation
by considering not only the role that different investments might play in the portfolio, but how and in what ways such investments contribute to or
mitigate various forms of portfolio risk as measured by standard deviation or volatility of returns.
Commodities generally are volatile and are not suitable for all investors. This material must be accompanied or preceded by
the prospectus. Carefully consider each Trusts investment objectives, risk factors, and fees and expenses before investing.
Please click here to view the prospectus.
ALPS Distributors, Inc. is the marketing agent for ETFS Silver Trust, ETFS Gold Trust, ETFS Platinum Trust, ETFS Palladium
Trust and ETFS Precious Metals Basket Trust.
Maxwell Gold is a registered representative of ALPS Distributors, Inc.
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