What’s the most despised industry sector in the market today? Solar stocks? China frauds? Sure, you can average down on these to zero. What about a real industry that’s starting to finally hemorrhage cash flow? After a decade of continually disappointing investors, large cap gold stocks are finally cheap.
Will they continue to disappoint investors? Of course they will. They’re gold stocks after all, but they’re just too cheap. They’ve finally caught up with depletion. They’ve finally paid off debt. They’ve finally debugged big cap-ex projects and they’ve finally started to produce gold at prices that get them some cash flow. I don’t trust analyst estimates, but most analysts seem to imply that the 5 largest producers trade for around 6-8 times cash flow using about $1600 gold. Even with cost inflation, that just doesn’t seem too expensive. Sure, these things were overvalued when they were valued at 20 times cash flow, back in 2004, but single digit cash flow yields with growing production should finally get some investor attention.
Will the miners continue to overpay for assets? Will they continue to invest in countries that I wouldn’t dare go on vacation (think of my travel schedule—not yours)? Will they continue to invest in projects based on fantasy metrics where paybacks are below their cost of capital? C’mon, these are gold mining stocks. We all know they will. These things are run by some of the stupidest people I have ever met. But they just cannot seem to destroy enough value at these prices to go much lower—no matter how hard they try.
I won’t go through the individual numbers, because frankly, I refuse to own any one of these things. They’re all toxic. But an index of these things should insulate you a bit.
The chart above is a ratio of the XAU (Philadelphia Gold and Silver Index) divided by the price of the gold itself. As you can see, for most of the bull market in gold, at least until 2008, it traded at between 20% and 25% of the price of gold. As gold went up, so did the index. Then the crash came and investors were burnt by the miners. Since then, the miners have not come close to recovering the old ratio. Even more amazingly, the ratio is getting pretty close to the panic lows of late 2008. That turned out to be a great time to own the XAU as it proceeded to more than triple over the next year and change.
I’ll admit that I bought some GDX on Friday, more for giggles than a real position—I’ve sworn off individual miners on principle. However, I cannot ignore these charts—they really spell opportunity. What are they telling us? Either miners as a group are VERY cheap, or gold is about to implode in price. I really doubt that the latter is possible. Maybe gold stocks are just too cheap and ready to finally work higher for a change.