Gold was up for an 11th straight year, a remarkable run. But most gold stocks have performed poorly for several years. Throughout the past five years, the price of gold has more than doubled, while the XAU index of major gold stocks is essentially flat. Yet mining stocks are supposed to be leveraged investments on gold, and they once behaved as such. During the first five years of the latest gold bull market, gold stocks rose sevenfold while bullion "only" doubled. What went wrong?

There are several reasons why gold stocks have underperformed:

* Competition from gold ETFs hurt miners. The largest, the SPDR Gold Trust, was introduced at the beginning of 2005. Offering a direct play on gold without the vagaries of mining, the ETFs made buying gold easy. Prior to that, the gold mining stocks had been about the only choice for investors who wanted exposure to the metal.

* Gold mining is a tough business. It is difficult to replace the millions of ounces mined each year. Increasing environmental, social and government challenges have made exploration, development and production more protracted.

* Mining has not been particularly profitable. Major costs (particularly energy and currencies where mines are located) have risen faster than gold prices. The so-called cash cost of mining is only one - and a relatively minor part at that - of a company's overall costs.

* Most analysts have been too conservative in their gold assumptions. Throughout the bull market, the gold price used by analysts to value gold stocks has significantly lagged reality, so price targets for gold stocks were always modest. Even now, many analyst reports on individual companies use $1,300 as their measure.

* Gold stocks, as equities, reflect the stock market as well as the gold price.

There are reasons to believe this is changing. Mining companies have become more disciplined and have started to emphasize dividends, a way of differentiating themselves from ETFs and gold itself (which of course yields nothing). Margins are now expanding.

Gold stocks are now trading close to 20-year valuation lows, relative to the bullion. They could play catch-up. If gold moves up as the broad stock market continues to rally, gold stocks will likely be among the top-performing sectors this year.


Adrian Day is founder and president of Adrian Day Asset Management in Annapolis, Md., and author of Investing in Resources.