According to a friend, “Since XAU was first invented in 1984, there have only been six days when the ratio of XAU to spot gold has been lower than it was at this morning’s bottom; all of those six days occurred during October-November 2008. The extreme unpopularity of gold mining shares is striking especially when compared with the eagerness of average people to consider precious metals in one form or another, such as via exchange-traded funds.”
Let’s start with the obvious, just because a certain ratio has existed for 28 years, that doesn’t mean that it has magical predictive powers, or that it cannot get even more stretched. However, these ratios do tend to be useful indicators over time and 28 years is a lot of predictive history. There are two ways that this ratio can get resolved in the next few months; either gold mining shares increase in price or the price of gold declines dramatically. With all the macro-economic issues in the world about to erupt again, I seriously doubt that gold drops substantially.
Is this a unique opportunity to own mining shares? Unquestionably it is. The bigger question is, are we at the bottom? Would I own the miners here? I already do, and I’ve been adding lots more in the past few days.
Let’s face it, they’re all terrible companies. I don’t have the skills needed to choose which are less terrible. Instead, I’ve bought mostly Market Vectors Gold Miners (GDX) and Market Vectors JR Gold Miners (GDXJ). This way, I can let a bunch of indexers choose which miners I’m stuck with. I’m sure I’ll get mostly the bad ones—but a few of the good ones too. In the end, it’s all one trade and these things are terribly oversold.
I wouldn’t want to own miners for a long term investment, but at these prices, even that seems enticing. Based on analyst estimates (and I don’t really trust analysts), the miners now trade at something like 5-7 times cash flow. They’re sending you some of this cash flow in dividends which are now approaching 2-3% and using the rest to reinvest in projects with returns on capital north of 20% using current metal prices. They all have cash flow—the dilutive capital raises are over. The debts are being paid down and the depletion issues are being solved as they ramp up exploration spending. Many of the newer mines are about to ramp up production. These are the mines that have been vexing investors for years as they have massive cost overruns. Once online, these will stabilize production costs.
In the next two weeks, the majority of the large cap producers will report earnings. I can already envision the press releases; reduced production guidance, missed earnings, cost overruns, lower than expected margins, rapidly increasing labor costs, government interference, too much rainfall, in general they will all bomb their quarters. What else is new in gold mining? But after the downgrades are finished, people will hopefully come to realize that most of the majors now have growing production pipelines and trade for very low multiples to current and future cash flows.
I cannot remember seeing a sector that is more hated. The sentiment is just awful. None of my friends can even bare to look at their screens any more. According to the Hulbert Gold Newsletter Sentiment Index, the majority of gold newsletters are recommending that their readers get short gold. Remember, these are the same guys who mostly make their money selling subscriptions to lunatics who think the government is coming to confiscate their gold. These newsletters are now net-short and have been suggesting for their readers to get short for almost a month now!!! MarketVane and other sentiment indices say similar things. Of course, you can take a poll of my friends and get comparable results.
Me: “Why is Goldcorp down so much today?”
Friend: “It mines gold…:(”
I want to point out that this isn’t an investment for me—I no longer invest in gold mining stocks. However, I can see the potential for a multi-month trade with 20 to 30% upside and not much real downside besides a few day panic low. I’m finding my spots and adding to GDX and GDXJ. The miners feel like they’re going to zero, which is usually about when you want to own them.
Disclosure: My fund is long GDX and GDXJ. It may add or reduce these positions without further notice. This is not a recommendation or solicitation to do anything. Caveat Emptor.