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By Janet Yang, CFA | 11-15-2012 01:00 PM

Gold Stocks Ready to Outperform

Although gold equities have lagged the performance of bullion, miners will do a much better job of executing and delivering margin expansion to investors, says Fidelity's Joe Wickwire.

Janet Yang: Hi, I am Janet Yang, a mutual fund analyst here at Morningstar. Today I have with me Joe Wickwire from Fidelity. Joe is the portfolio manager of Fidelity Select Gold.

Thank you, Joe, very much for joining us.

Joe Wickwire: My pleasure. Thanks for having me.

Yang: I was thinking maybe we start at the high level in terms of what's been going on with gold funds and with the equity precious metals area, in general.

If you look at the past 10 years, I think, investors have enjoyed double-digit returns for almost every single one of those years; 2011 was an exception. It looks like 2012 is going to be, as well. At the same time you have gold bullion, physical gold, still kind of continuing that streak. Can you maybe talk about why there has been this kind of disconnect between gold equities and physical gold? I think when we look at year-to-date numbers, for example, the average gold miner or the average gold fund is trailing gold bullion by about 11 percentage points.

Wickwire: What you are pointing out--the disconnect between the gold equities and the performance of gold bullion--is in fact the third time it has happened over the last 10 years. It happened in 2004 and 2005 for roughly 17 months, and it ended in May of 2005 when the French and the Dutch voted down the European constitution. It happened in a truncated fashion in 2008 due to the financial crisis. And then it's happened again over the last year and a half. I think that in May of this year the gold stocks ended another 17-month period where they underperformed the gold bullion and have since done much better, especially over the summer when the gold stocks moved up roughly 30% versus a 10% move in gold bullion.

So, the question is, why did we have these periods where you get this disconnect? And it happens because stocks are forward-looking mechanisms. So, when the market has a degree of skepticism about where the gold price is going or it doesn't believe the gold companies are going to be able to deliver margin expansion against the backdrop of a rising gold price, then the gold stocks typically put in a period of underperformance versus the gold bullion.

Now, as in 2004 to 2005, when that period ended the gold stocks put in a period of two-and-a-half years of outperformance versus the bullion, and in 2008 the same thing happened--after a period of underperformance you had another two-and-a-half years of outperformance of the equities versus the bullion. And I think again ending in this most recent period--where I think May was probably the bottom for the more recent period of disconnect--I think we are set up for a period where the gold stocks should put in a period of outperformance versus gold bullion because I do want to believe that gold is still biased to the upside. And I think the gold companies are going to do a much better job of executing and delivering margin expansion to investors, especially potentially against a backdrop of an investible universe where maybe margin expansion is not going to be as widespread as perhaps in the gold space.

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