Why do gold fund prices not mirror the movement of gold bullion prices?

Posted on 19 January 2012 by Douglas Chadwick

Well this is a question that has puzzled me for the last few months. Recently we have observed the gold price move from 1500 dollars an ounce up to 1900 dollars and then back down 1500 dollars an ounce, and now it’s moved up to 1600 dollars an ounce. Yet during this same period gold funds fell and then fell some more and only recently showed some gains. Now that's odd. Why is there not a direct link between the bullion price and the value of mining shares and by association gold fund prices? 

The obvious observation is that the cycle of bullion prices and the cycle of the exploration industry values are out of kilter. But why? Well I guess on consideration that does kind of make sense. Bullion prices go up as the media and political circumstance talk the demand up. Experience shows us that this can happen quite quickly. But then there is not enough supply. So the mining and exploration companies go into overdrive to exploit existing sources and to find new mines. Now this will mean raising capital, getting mining permits, opening new mines and lots and lots of drilling. Some of this will be successful and some will not. This is a long and expensive period maybe stretching over years. So the higher bullion prices will have generated lots of activity but not necessarily profit for the mining companies. 

Understandably the value of the mining companies will be trailing the bullion prices. Now it is possible if not probable that the reverse is also true. Gold bullion completes the upward run of its cycle ,be this for reasons economic, political, or simply fashion, and its price falls. At this time the mining business is bringing on that extra capacity that was being demanded and even at these reducing bullion prices they are very profitable and their value rises. This will continue until the bullion price falls to a level that makes them unprofitable and the dual cycle is completed. That is until it all starts again. 

This must be a very trivial look at these cycles but it sort of makes sense to me. I guess onto the top of all of this one has to add the effect of hedging, where the big fund managers are buying and selling forward trying to anticipate these movements. Trying to understand this is one step to far for me, so I stop here.