Gold mining companies and the price of gold

• Published date: 01 November 2014
• DOI: http://doi.org/10.1016/j.rfe.2014.07.001
• Date: 01 November 2014

Gold mining companies and the price of gold☆

Dirk G. Baur

UTS BusinessSchool, PO Box 123 Broadway,Sydney, NSW 2007, Australia

abstractarticle info

Articlehistory:

Received19 November 2013

Receivedin revised form 26 June 2014

Accepted2 July 2014

Availableonline 1 August 2014

Keywords:

Gold

Gold miningstocks

Asymmetricpayoff

Real options

Exchange-traded funds

Thispaper studies the exposureof Australian gold miningfirms to changes in the gold price. We usea theoretical

framework to formulate testable hypothesesregarding the gold exposure of gold mining firms. The empirical

analysis based on all gold mining firms in the S&P/ASX All Ordinaries Gold Index for the period from January

1980 to December 2010 finds that the average gold beta is around one but varies significantly through time.

The relatively low average gold beta is attributed to the hedging and diversificationof gold mining firms. We

furtherfind an asymmetric effect in gold betas,i.e. the gold exposure increaseswith positive gold price changes

and decreaseswith negative gold price changes consistentwith gold mining companiesexercising real options

on gold.

© 2014 ElsevierInc. All rights reserved.

1. Introduction

Investorswho want exposure to the priceof gold can buy gold bars,

gold coins, shares of exchange-traded funds on gold or invest in gold

mining firms. Theoretically, the latterprovides a leveraged investment

into gold since a share in a gold mining firm does notonly give access

to one unit of gold but a share in the total future prod uction of the

gold miner. If a gold mining firm furtheruses managerial flexibility to

expand in times of rising gold prices and to contract (including the

temporaryclosure of mines) in timesof falling gold prices, goldmining

shares may be a superior alternative to physical gold investments. In

other words, since gold mining firms hol d real options on gold with

the exercise price being their mar ginal production costs, they c an

provide an asymmetric exposureto gold yielding higher returns.

This study aims to analyze the performance of gold mining firms

relativeto the price of gold and provideinformation about thevalue of

the real options held by the firms, the hedging activities and the

managerial flexibility of the firms. We focus on firms that are part of the

Australian gold mining company index listed on the Australian stock ex-

change. Since Australia is the second largest gold producing country

1

an

analysis ofAustralian gold mining firmscan provide interestingresults

on its own and if compared to the literature that focussed on other

countries.

Thestrong positive trendin the price of goldbetween 2004 and 2010

providesan additional motivationand feature that is particularly inter-

estingfor the question whethergold mining firms activelyuse their real

optionson gold and thus provide an asymmetric exposureto gold price

changes. The 2004–2010 period is also characterized by the introduc-

tion and increased popularity of exchange-tradedfunds on gold. Since

shares in exchange-tradedfunds are financial claims on gold and thus

an alternative to both direct physical investments and equity invest-

ments an analysis of this period can provide information on how the

introduction and presence of ETFson gold have affected the exposure

of gold mining firmsto the price of gold.

This study is related to earlier wo rk that analyzes the stock price

exposure of gold mining firmsto gold (see Blose & Shieh, 1995; Faff &

Chan, 1998; Faff & Hillier, 2004; Tufano, 199 6; Tufano, 1998; Twite,

2002). While many studies focus on Nort h American gold mining

firms (e.g. Tufano, 1996, 1998), thi s research follows Faff and C han

(1998) and Twite(2002) and studies Australian gold miningfirms b ut

extends the existing literature as fol lows: First, we use a theoretical

framework to formulate hypotheses about the gold exposure of gold

mining firms. Second, by using the lo ngest sample period among all

existing studies the data comprise sign ificant bear and bull market

regimes and are thus well-suited f or an analysis of asymmetric gold

betas and real optionality.Relatively short sample periods may not be

composed of different gold market con ditions or regimes and thus

provide biased estimates of the importanceof real optionality.

2

Third,

we analyze the exposure of gold mining firms assumin g constant,

asymmetricand time-varying exposure.

Reviewof Financial Economics 23 (2014)174–181

☆I wouldlike to thank two anonymousreferees, TimothyBalin and Isaac Miyakawafor

excellentresearch assistanceand my colleaguesKris Glover and AdrianLee for comments

that greatlyimproved the qualityof the paper.

E-mailaddress: dirk.baur@uts.edu.au.

1

Australiaproduced the second largest amount of gold (in tonnes) in 2011 and 2012.

China is the largest producer and the US is the third largest producer (see Thomson

Reuters GFMS Gol d Survey, 2013).

2

Therelatively stable goldprice in the 1990s isan example of a period thatis not com-

posedof different gold market conditionsor regimes.

http://dx.doi.org/10.1016/j.rfe.2014.07.001

1058-3300/©2014 Elsevier Inc. All rightsreserved.

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