How to Mine Gold Without Digging

Abstract

This paper examines the main drivers of the returns of gold miner stocks and ETFs during 2006–2017. We solve a combined optimal control and stopping problem to demonstrate that gold miner equities behave like real options on gold. Inspired by our proposed model, we construct a method to dynamically replicate gold miner stocks using two factors: the spot gold ETF and market equity portfolio. Furthermore, through each firm’s factor loadings on the replicating portfolio, we dynamically infer the firm’s implied leverage parameters of our model using the Kalman Filter. We find that our approach can explain a significant portion of the drivers of firm implied gold leverage. We posit that gold miner companies hold additional real options which help mitigate firm downside volatility, but these real options contribute to lower returns relative to the replicating portfolio when gold returns are positive.