8102019 Wrap Sheet - Jun 17 2011

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that same period the XAU underperformed rising a measly

21 We have constructed our own capitalization-weightedgrouping of 10 international gold companies removing thesilver and base metals bias that characterizes the XAU Thatgroup is up 28 Lastly we have crunched the return for the11 Canadian gold miners spotlighted in our 2011 Gold SurveyThese are up 73 See figure 2 for the respective changesweightings and constituents

While the mid-caps in the Canadian-11 group have outper-formed the stocks in our International-10 group in generalstocks have underperformed gold In the table on the oppositepage we show the market capitalizations for ourCanadian-11 and International-10 groupings Starting from a market cap of

$30 billion at the end of 2007 the value of theCanadian-11 has jumped to $67 billion The market cap of the International-

11 has run up from $137 to $202 billion The total values ofour two indexes have risen by 124 and 48 respectively

Figure 3 opposite page puts everything in perspective Whilethe price of the average share in the Canadian-11 has underper-formed gold the increase in their combined market cap hasalmost doubled that of the metal While the average interna-tional minerrsquos market capitalization is still underperforminggold this market cap is still increasing twice as fast as the aver-age international minerrsquos share price

The rise in gold company valuations since the end of 2007 is

due in no small part to the flood of new capital entering themarket Over the last three years about $17 billion in new

Why wersquore not so sure that the values of gold equities are lagging the price of gold

There has been much hand-wringing among gold equity investors

of late The average gold share seems to have forgotten that it isindeed a gold share and that it should be scooting on higherhand-in-hand with its big brother the metal In fact one wouldexpect that the operating leverage that mining companies have tothe gold price would juice their performance such that an xincrease in gold would equate to an x+n increase in shareprices But the shares seem to have lost their way While observ-ers are right that the average price of a gold share has been lagginggold our view is that the overall market capitalization of the goldindustry has been increasing much faster than the price of theaverage share This is because even though share prices have beendilly-dallying exuberant growth in share issuance has more thancompensated As such the mysterious gold-share divergence isnot really a divergence since the gold companiesrsquo collective mar-ket capitalization and not their price has much better approxi-mated the rising gold price

First we present the evidence for weak prices The most popu-lar way to measure the relative strength of gold shares vs physi-cal gold is to take the ratio of thePhiladelphia Gold amp SilverIndex (XAU) to the gold price We submit figure 1

The XAU gold index managed to maintain a fixed even slightlyrising ratio to the gold price through the first few years of thegold bull market Everything was as it should be But starting in2006 the XAU began to fall relative to gold with the fall acceler-

ating during the credit crisis of late 2008 Shares managed torally briefly versus the metal in 2009 but this rally stalled andthe XAUrsquos relative weakness continues in 2011

Next wersquoll focus in on the last three or so years From the end of2007 to May 31 2011 the spot price of gold rose 84 Over

Gold vs Gold Shares A divergence

Pollitt amp Co Inc

11 King Street West Suite 1950 Toronto ON Tel 4163653313

625 Boulevard Reneacute Leacutevesque Ouest Bureau 930 Montreacuteal QC Tel 5143958910

8102019 Wrap Sheet - Jun 17 2011

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shares has been issued by the Canadian-11 and $26 billion by theinternational players

This underlines the main difference between the physical goldmarket and the gold share market When demand for gold risesthe sole way that demand can be satisfied is through existing

ounces of the metal coming to the market or new ounces minedthrough sweat and tears Only a higher gold price can coax theseounces out But when the demand for gold shares rises this de-mand can be met by either existing shares coming to market ornewly-printed shares coming to the market Thus unlike goldhigher equity prices are not needed to coax shares onto the mar-ket to meet demand since eager mine promoters are more thanwilling to meet that demand at existing share prices by creatingshares out of thin air That is why we see the phenomenon of arising gold price lagging gold share prices and outperforminggold market capitalization

The massive dilution that gold companies have perpetrated on

existing shareholders has only compounded gold sharesrsquo under-performance relative to the metal With many miners issuingnew shares and the gambling public more than willing to snapthese issues up there has been an artificially large amount of newfunds entering the mining camps driving up the price of every-thing from washed-up gold mines machinery mining wagesdrilling contractors and mine engineering costs The result isthat any rise in the gold price has been eroded by these highercosts Had gold companies not issued so many shares and thegold investing community been less tolerant of dilution lessmoney would be chasing the limited number of miners contrac-tors etc and the operating position of gold companies would be

less precarious

The information contained in this report is believed to be reliable but its accuracy andor completeness is not guaranteed All opinions estimates and other information included in this report constitute our

judgement as of the date thereof and are subject to change without notice Pollitt amp Co Inc does not issue ratings or price targets on any securities mentioned within this letter nor does Pollitt amp Co Inc

maintain and publish current financial estimates and recommendations on securities mentioned in this publication Pollitt amp Co Inc discontinues coverage of the stocks highlighted in this letter For informa-

tion on our policies on research dissemination please see our website wwwpollittcom Stock Recommendation System and Terminology Pollitt does not issue price targets for companies Pollitt intends to

maintain a Buy List of 10-15 stocks The listing of a stock on the Buy List should be considered as advice to carry a position in that stock The removal of a stock from the list should be considered as advice to

reduce a position in that stock Pollitt provides continuous coverage of all stock ideas on its Buy List The only stocks currently on the Buy List are Franco-Nevada Reitmans Fibrek and Softchoice

Gold mining is a tough business that typically yields low returnson capital But it has always attracted its fair share of dreamersand as a result gold shares tend to be issued in such tremen-dous amounts and at such high valuations that they never out-perform the metal for any extended period of time Theldquodivergencerdquo between shares and the metal is not so much adivergence as a convergence to the mean

John Paul Koning jpkoningpollittcom

Toronto Ontario June 17 2011

Table 1 The values of Pollittrsquos two gold indexes

983107983144983137983150983143983141983155 983142983154983151983149 983108983141983139 983091983089983084 983090983088983088983095 983156983151 983117983137983161 983091983089983084 983090983088983089983089

983106983145983148983148983145983151983150 983076

983107983137983150983137983140983145983137983150983085983089983089 983113983150983156983141983154983150983137983156983145983151983150983137983148983085983089983088

983113983150983145983156983145983137983148 983117983137983154983147983141983156 983107983137983152 983091983086983088 983089983091983095

983109983150983140 983117983137983154983147983141983156 983107983137983152 983094983086983095 983090983088983090

983076 983107983144983137983150983143983141 983091983086983095 983094983093

983077 983107983144983137983150983143983141 983089983090983092983077 983092983096983077

983109983153983157983145983156983161 983154983137983145983155983141983140 983089983086983095 983090983094

8102019 Wrap Sheet - Jun 17 2011

httpslidepdfcomreaderfullwrap-sheet-jun-17-2011 22

shares has been issued by the Canadian-11 and $26 billion by theinternational players

This underlines the main difference between the physical goldmarket and the gold share market When demand for gold risesthe sole way that demand can be satisfied is through existing

ounces of the metal coming to the market or new ounces minedthrough sweat and tears Only a higher gold price can coax theseounces out But when the demand for gold shares rises this de-mand can be met by either existing shares coming to market ornewly-printed shares coming to the market Thus unlike goldhigher equity prices are not needed to coax shares onto the mar-ket to meet demand since eager mine promoters are more thanwilling to meet that demand at existing share prices by creatingshares out of thin air That is why we see the phenomenon of arising gold price lagging gold share prices and outperforminggold market capitalization

The massive dilution that gold companies have perpetrated on

existing shareholders has only compounded gold sharesrsquo under-performance relative to the metal With many miners issuingnew shares and the gambling public more than willing to snapthese issues up there has been an artificially large amount of newfunds entering the mining camps driving up the price of every-thing from washed-up gold mines machinery mining wagesdrilling contractors and mine engineering costs The result isthat any rise in the gold price has been eroded by these highercosts Had gold companies not issued so many shares and thegold investing community been less tolerant of dilution lessmoney would be chasing the limited number of miners contrac-tors etc and the operating position of gold companies would be

less precarious

The information contained in this report is believed to be reliable but its accuracy andor completeness is not guaranteed All opinions estimates and other information included in this report constitute our

judgement as of the date thereof and are subject to change without notice Pollitt amp Co Inc does not issue ratings or price targets on any securities mentioned within this letter nor does Pollitt amp Co Inc

maintain and publish current financial estimates and recommendations on securities mentioned in this publication Pollitt amp Co Inc discontinues coverage of the stocks highlighted in this letter For informa-

tion on our policies on research dissemination please see our website wwwpollittcom Stock Recommendation System and Terminology Pollitt does not issue price targets for companies Pollitt intends to

maintain a Buy List of 10-15 stocks The listing of a stock on the Buy List should be considered as advice to carry a position in that stock The removal of a stock from the list should be considered as advice to

reduce a position in that stock Pollitt provides continuous coverage of all stock ideas on its Buy List The only stocks currently on the Buy List are Franco-Nevada Reitmans Fibrek and Softchoice

Gold mining is a tough business that typically yields low returnson capital But it has always attracted its fair share of dreamersand as a result gold shares tend to be issued in such tremen-dous amounts and at such high valuations that they never out-perform the metal for any extended period of time Theldquodivergencerdquo between shares and the metal is not so much adivergence as a convergence to the mean

John Paul Koning jpkoningpollittcom

Toronto Ontario June 17 2011

Table 1 The values of Pollittrsquos two gold indexes

983107983144983137983150983143983141983155 983142983154983151983149 983108983141983139 983091983089983084 983090983088983088983095 983156983151 983117983137983161 983091983089983084 983090983088983089983089

983106983145983148983148983145983151983150 983076

983107983137983150983137983140983145983137983150983085983089983089 983113983150983156983141983154983150983137983156983145983151983150983137983148983085983089983088

983113983150983145983156983145983137983148 983117983137983154983147983141983156 983107983137983152 983091983086983088 983089983091983095

983109983150983140 983117983137983154983147983141983156 983107983137983152 983094983086983095 983090983088983090

983076 983107983144983137983150983143983141 983091983086983095 983094983093

983077 983107983144983137983150983143983141 983089983090983092983077 983092983096983077

983109983153983157983145983156983161 983154983137983145983155983141983140 983089983086983095 983090983094