The following article discussing gold prices vs mining shares appeared on Barrons in October 2017, and the original can be found here.

Miners Play Catch-Up to Gold and Silver Prices

The yellow metal has outperformed mining shares this year. Expect a rally ahead of a move higher in gold prices.

Gold has outperformed mining shares so far this year, but the tide may turn in coming months if mining companies report strong results and optimism rises over the outlook for precious-metals prices.

The relative value of gold-mining shares is “still quite low” versus the price of the yellow metal itself, and mining shares “could begin to rally ahead of a much larger move higher in gold prices,” says Peter Spina, president and CEO of precious-metals information provider Gold miners, which are poised to report quarterly results over the next few weeks, may “start to see that gold is brewing up for a big price breakout,” prompting that stronger advance in share prices.

Year to date, the Philadelphia Gold and Silver Index and NYSE Arca Gold Bugs Index are trading nearly 8% higher, while gold futures, which settled at $1,280.50 an ounce on Friday, and the gold-backed SPDR Gold Sharesexchange-traded fund (ticker: GLD), have risen by more than 11% so far this year. “Gold mining is a business that is challenging both in terms of the operating environment, and the underlying burden” of operational and capital expenditures, says Tim Seymour, an advisory board member with fund manager InfraCap. “Gold miners trade at a discount for a reason.”

“Gold and silver have had the perfect storm of a weaker dollar” and extensive geopolitical risk, “married to uber-accommodating global central banks creating pressure on fiat currencies and asset bubbles everywhere,” says Seymour. That has buoyed prices so far this year. Over the past 18 months, he says, gold prices are actually flat, and “many miners have been using the calm as a place to repair balance sheets and sell off noncore assets” to improve free cash flow.

Seymour says he’d prefer to be “long diversified miners, rather than precious-metals miners,” as global growth expectations should “continue on an upward trend.” That is driving copper, zinc, tin, and steel demand. He says diversified miners such as Rio Tinto(RIO.UK) and Antofagasta (ANTO.UK) are more leveraged to the global economy.

But Jeb Handwerger, publisher of the Gold Stock Trades newsletter, believes junior miners, which are engaged in exploration, could make significant gains. The big producers are poised to run out of replaceable reserves by the end of the decade, as declining exploration budgets and lack of new discoveries generate a peak in production, he says.

Year-to-date gains of 11% in the VanEck Vectors Gold Miners ETF (GDX), which includes big names such as Newmont Mining (NEM) and Barrick Gold (ABX), roughly match that of gold prices. The VanEck Vectors Junior Gold Miners ETF (GDXJ), however, whose top holding is Gold Fields (GFI), has fallen behind, climbing by less than 6%.

THAT MAY CHANGE. Major miners will “need to acquire the juniors at significant premiums,” says Handwerger. “The rest of this year into next could be a scramble for some major producers to secure the best potential supplies from junior developers and explorers.”

Spina expects solid earnings from gold miners, which could send shares higher. The higher quarterly gold-price average helped lift profits for gold miners, and with their costs mostly fixed, the “higher price means more margin.” Gold stocks that “outperformed their peers in the past year’s rallies…are the ones [investors] should be buying on weakness,” Spina says, adding that Golden Star Resources (GSS), a midtier producer, which pursues higher production at its mines while cutting costs, fits that bill and is “likely to be one of these leaders.”

The midtiers and junior producers are usually more leveraged to the gold price in a rising market, says Spina, so “if the gold price is going higher…gold stocks will go up, but the smaller gold stocks should go up the most.” Senior producers are “more stable, but not as attractive, since they’ve been eating through reserves and will have to start acquiring more ounces or other miners.”

Still, he says, “even if gold prices held [in the] $1,250 area, gold stocks have the potential to move 25% to 50% or more to make up for” their underperformance versus gold prices. “The downside risks versus upside potential reward are increasingly becoming more favorable, and once the price begins to make technical breakouts, the momentum buyers and sideline money will flood back into gold stocks.”

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