The Miners

[MediumTex]

When do the miners start reflecting the higher profits that rising gold and silver should produce in the future?

So far, I think the market has questioned whether high gold and silver prices were here to stay.  As the market begins to believe otherwise, what should one expect to see in the mining sector?

The miners appear to have lagged the metals in recent years.  When does this turn around?

[Wonk]

When do the miners start reflecting the higher profits that rising gold and silver should produce in the future?

So far, I think the market has questioned whether high gold and silver prices were here to stay.  As the market begins to believe otherwise, what should one expect to see in the mining sector?

The miners appear to have lagged the metals in recent years.  When does this turn around?

Sometimes it's all a matter of perspective.  It appears miners have lagged in recent years but I think the case could be made that the miners got ahead of themselves a bit before the steep correction.  I happen to think PM miners are one of the most attractive sectors right now.  Over the last 10 years, gold has returned 585% since the lows in 2001.  Miners as a whole have returned 1150% in the same time frame. 

[AdamA]

When do the miners start reflecting the higher profits that rising gold and silver should produce in the future?

I have heard it said that the fact that this hasn't happened yet is a good sign for the precious metals market, in that in indicates people are not speculating excessively. 

[HB Reader]

Wonk -

I very much agree.  The miners got crushed in 2008 after getting ahead of themselves -- far more than the physical metals.  That shook out a lot of speculative excess.  It set up the attractive VP situation we have today.  I suspect that pretty soon we will begin to see higher earnings and much more investor interest and the sector will become a "story," particularly the smaller miners.  Especially if the broad stock market continues to hold up. 

[murphy_p_t]

MT,

Many gold bugs are wondering the same thing!

For example, from an interview on kingworldnews.com

When asked about the underperformance of gold shares Turk responded, “It’s depressing to see the mining share action today with gold and silver putting in such strong performances.  But don’t let your emotions fool you and send you in the wrong direction.  Sometimes the markets really do try your patience and this is one of those moments that we are seeing right now in the mining shares.  KWN readers should continue accumulating the mining shares because at some point in the near future we will see a move that will be absolutely breathtaking.”?

(BTW, I find the KWN interviews to be very enlightening)

[murphy_p_t]

i just read this article...not sure I buy into it. (Why Gold Stocks are Struggling Despite Record Price )

http://www.kitco.com/ind/Trendsman/apr182011.html


In particular, the part about weak dollar being a drag on mining shares seems suspect and not a dominant driver. Seems to imply that companies like Barrick don't know how to hedge their input costs.

Can anyone comment?

[AdamA]

Can anyone comment?

I think it may be because people are running to gold due to fear more so than for speculative purposes. 

It's a strange thing, and in my mind potentially a signal that we are in very deflationary environment. 

I wonder what would happen if interest rates started to rise...

Typically, people say that when rates rise, money would be inclined to leave gold (no interest investment) for other higher yielding investments (stocks, bonds).  I think that in this environment if interest rates began to rise, it may be interpreted as a signal that inflation was indeed becoming a problem, at which time I think miners might shoot up right along with the metal. 

Counterintuitive, and maybe silly, but just a thought...

[Storm]

Adam, I would have to agree with you.  Interest rates rising would seem to be a sure indicator of inflation and should cause gold as well as the miners to reach all new record highs.  Based on 1979-1980 historical interest rates, this seems to be a sure indicator that gold is heading towards a "blow off top":

Third Quarter 1980 18.22%
Second Quarter 1980 15.39%
First Quarter 1980  14.28%
Fourth Quarter 1979 11.70%

I've only held GDX in my VP for the last 9 months or so, but it sure has been frustrating to see a 20% or 25% rise in gold and only a 5% or so rise in miners.

Also, the miners should be doing extremely well with silver the way it is - 10% of what they pull out of the ground is silver.  It seems miners are tremendously undervalued right now.

To take the "what if I'm wrong approach", this could also be due to high input prices like oil, which might weigh heavily on miners.  I would hope that most foreign miners could hedge currencies effectively to actually benefit from a falling dollar as opposed to suffering from it, but who knows?

[Wonk]

To take the "what if I'm wrong approach", this could also be due to high input prices like oil, which might weigh heavily on miners. 

Almost paradoxically, miners actually do perform better in deflationary environments where the gold/commodity basket ratio is increasing.  Like all businesses, higher input costs relative to finished sales prices results in margins that are increasingly squeezed.  If input costs are rising at the same rate or faster than gold prices, miners will struggle. 

The mining industry is high-risk/high-reward.  Investors want to see fat earnings (or the high likelihood) before making a commitment.  Usually several quarters of strong earnings are necessary for such a commitment.  I agree the miners as a sector are undervalued right now but it will be interesting to see what happens with oil moving forward.

[Storm]

I feel like I can't win with GDX.  Gold hits a record $1520 high, but Barrick announces they are purchasing a junior miner and the index tanks.

I'm looking at YTD returns on GDX of only 2.03%, while SGOL has had 6.52%.  Somethings gotta give.  I'm going to hold on for those big returns... With $1500+ gold prices and $50+ silver, they have to be making some serious money pulling this stuff out of the ground, but Wall Street doesn't seem to think so.

Maybe this GDX speculation is for chumps... I should have bought the September 1st GLD $1700 options I was contemplating... They were only 50 cents each a couple weeks ago.  Imagine if gold popped to $1800 by then by going parabolic...  A $1,000 small change bet could turn into $200,000 overnight.

[AdamA]

Imagine if gold popped to $1800 by then by going parabolic...  A $1,000 small change bet could turn into $200,000 overnight.

Careful...You're gonna drive yourself nuts. 

[MediumTex]

Wonk,

I'm ready for your updated analysis of the miners.

I assume it's a good time to buy, but I wanted to see what your thoughts are.

[Wonk]

Wonk,

I'm ready for your updated analysis of the miners.

I assume it's a good time to buy, but I wanted to see what your thoughts are.

Uncanny.  I had my buy order for GDXJ filled with 9 seconds left in the session today.  I was coming here to put it out in public and saw your post.  We're on the same wavelength.  I'm going out to buy some carpet cleaning materials. 

I love the miners here.  One metric I keep my eye on is the XAU:GOLD ratio.  It hit 7.26 today, which is really cheap.  The higher it goes, the cheaper the miners are in relation to gold.  Anything over 4 has historically been a good time to buy miners.  John Hussman had some nice commentary explaining the ratio a while back.  Here's the article:

http://www.hussmanfunds.com/wmc/wmc050502.htm

If you're short on time, here's the juicy section:

To put some historical context on this measure, since 1974, the Gold/XAU ratio has been greater than 5.0 about 15% of the time. When the ratio has been this high, the XAU has followed with annualized gains of 89.6%, on average – a figure that remains high even if the data is split into multiple samples. When the ratio has been greater than 4.0, the XAU has followed with average annualized gains of 27.4% (though the finer profile of returns has been sensitive to other conditions such as interest rates, economic trends, and inflation). In contrast, when the ratio has been less than 3.0 (meaning that the gold stocks are very elevated relative to the actual metal), the XAU has declined at an annualized rate of -36.6%, on average.

The ratio has been range-bound in the 6-7 area for over a year.  This spike might be a blip on the radar or it could be signaling a waterfall decline in the mining equities like we witnessed in 2008, where the ratio hit 11.5.  That was probably a 5 or 6 standard deviation event, so I doubt we'd see that again.  But anything is possible.  In fact, if we hit those levels again, I will attempt to sell everything I have, including my wife's cat, to buy miners.  Back then, you could buy some miners for the cash they had in the bank.  It was insane.  I missed that as I was mostly in the orthodox PP back then, but if it happens again I'll back up the truck in a heartbeat.

The basic point is I really love the miners right now.  I think they were on the cheaper side before this sell-off, but I'm starting to salivate.  There could be a heckuva lot of pain ahead for the mining sector in the near future, but I'll be pinching my nose and buying all the way down if it gets that bad again.

[Wonk]

Here's a nice chart I just found to visualize the absurdity of 2008:

[HB Reader]

I agree with Wonk.  Over the next couple of days or weeks, I plan to sell a good portion of the Aug and Sept 2011 GDXJ and SIVR puts I had purchased a couple of weeks ago as insurance on my holdings in the smaller miners and silver.  This is strictly VP stuff.

Wonk, where do you get information on the smaller miners?  For a host of reasons, historically this has been a very difficult group to research independently.  I use a couple of current newsletters and have some older books and related material on the subject.  Since this is still largely a shunned market, individuals may actually have some (admittedly risky) opportunities.  GDXJ is the first fund -- ETF or mutual fund -- to come out in this area in which I would have any confidence.     

(Question to MT:  Are we allowed to give the names of current newsletters in the forum?  I know this isn't supposed to be an advertising vehicle.)

[MediumTex]

(Question to MT:  Are we allowed to give the names of current newsletters in the forum?  I know this isn't supposed to be an advertising vehicle.)

If you think it would be helpful to others, feel free to mention anything you want.

I would make it clear, however, that the forum or its management is not making investment recommendations, vouching for the accuracy of anything anyone posts, endorsing any particular investment, we're not experts, do your own due diligence, etc.

[Wonk]

Wonk, where do you get information on the smaller miners?  For a host of reasons, historically this has been a very difficult group to research independently.  I use a couple of current newsletters and have some older books and related material on the subject.  Since this is still largely a shunned market, individuals may actually have some (admittedly risky) opportunities.  GDXJ is the first fund -- ETF or mutual fund -- to come out in this area in which I would have any confidence.      

I'll occasionally read up on small miners, but I don't research them individually very often.  Unless I was personally involved with a mining company or I knew of a great manager working at one (eg-Rob McEwen at UXG), I wouldn't touch them individually.  I'm only interested in small/mid cap mining companies as a sector.  There are way too many problems in the mining industry that are magnified at a smaller capitalization.  I like the fact that for 59bps, Van Eck will pool 55 companies together for me.

Sure, someone will strike the motherload and buy XYZ mining for .02 and it'll shoot to $100, but it's not easy and there's way more luck to it than skill in my opinion.  Plus, we don't have reasonable certainty of who's a potential buyout target for the majors until after the deal is consummated.  For my money, I trust my analysis of where gold is going over the next few years and I'm willing to diversify the company risk across the entire sector.  As they say, "a rising tide lifts all ships."  

[HB Reader]

 There are way too many problems in the mining industry that are magnified at a smaller capitalization.  I like the fact that for 59bps, Van Eck will pool 55 companies together for me.

Yes, I like GDXJ as well.  It provides valuable diversification, very reasonable fees and can also be easily hedged or bought/sold with stop or limit orders.  I use it for about a third of my speculative PM position.

Sure, someone will strike the motherload and buy XYZ mining for .02 and it'll shoot to $100, but it's not easy and there's way more luck to it than skill in my opinion.  Plus, we don't have reasonable certainty of who's a potential buyout target for the majors until after the deal is consummated.  For my money, I trust my analysis of where gold is going over the next few years and I'm willing to diversify the company risk across the entire sector.  As they say, "a rising tide lifts all ships."  

Certainly the smaller the mining company, the greater are the risks (and luck) involved.  But I'm not necessarily talking about .02 to $100 penny stocks.  A reasonably diversified package of some of the better grade junior producers (many of whom are held in GDXJ) may offer pretty good returns over the next few years.  Such a package can also be hedged using GDXJ put options.  "Zeal Intelligence" (by Adam Hamilton) and "The Speculative Investor" by Steve Saville are two newsletters that cover this area pretty well.  Both Hamilton and Saville periodically offer free commentaries gleaned from their newsletters on the Kitco website.    

If you want to go the penny stock route and possibly get a lucky .02 to $100 moonshot, I'd suggest reading "Small Fortunes in Penny Golds" writted by Norman Lamb in 1973.  Essentially he says use speculative money and diversify very widely by using random selection.   I don't particularly suggest this approach, but the book is interesting and sort of a classic in the field.  His random selection approach came, in part, from the research leading to today's index funds.

DISCLAIMER:  This is all VERY speculative VP stuff.  I'm just throwing it out for anyone who is interested.  Have a solid PP before you even look at markets like this.  Penny mining stocks can bring to mind the old Robin Williams joke about cocaine:  "It's nature's way of telling you that you have too much money."    

[AdamA]

Great post, HB Reader.

You're obviously bullish on gold/gold miners over the next couple of years.  I'd be curious to hear what you think long term treasuries will do during this time.  Zeros?

[HB Reader]

Thanks, Adam1226.

Well, in my VP about 20% is currently in PM holdings (ETFs and smaller mining stocks).  So, yes I'm bullish on gold over the next few years, but I do hedge a portion of the exposure sometimes by using options or stop/limit orders.  This is the most leveraged part of my VP.

The only long term (over 6 years) bonds I currently hold is a small amount (~3%) in a TIP due in 2029.  No LTs, zeros or EDV.  So, I'm neutral to bearish on LTTs right now.  For the last several years, I have also used PRPFX as a sort of medium term (1-3 year) "holding vehicle" in the VP (mostly in a taxable account), so I guess there is also some limited LTT exposure there. 

My biggest holdings (~45%) are in dividend-paying stocks of (mostly US) companies I know well and have followed for many years.  Mostly big, some small.

Since this a VP, the above holdings COULD change at anytime, but I tend to move incrementally.  One of the few rules I have in my VP is to keep 20% in a five year ladder of zero coupon Treasuries and/or CDs (all in an IRA) spaced out about every nine months.  This provides some stability and a permanent amount of limited deflation protection.

For VP consideration only:  In case anyone is interested, by far the best source of free research/advice I've run across on more "mainstream" stock and bond investing is "The Wise Investor Group" (google their website), an independent group associated with RW Baird & Co.  Located in the Washington, DC-area, they do a local hour-long weekend radio show and a shorter weekly podcast on Wednesdays (available on iTunes).  The radio show and podcast are available next day free on their website.  I've listened to them for almost twenty years and personally know some members of the group.  They talk about very specifically about the investments they research and buy for clients and limit their self-promotion to a few short commercials.  They aren't Harry Browne adherents, so don't expect any PP discussion.  This is where I've told my wife to take our VP money if something happens to me.   

   

[moda0306]

HB Reader,

Do you not think the contraction of credit by Americans is much more deflationary than the printing of money is inflationary?

Do you think that contraction will continue?

[MediumTex]

Here's a nice chart I just found to visualize the absurdity of 2008:

Right now, the Gold/XAU ratio is at 7.63, which is higher than any time in the last 30 years, other than the 2008 spike.

What are we to make of that?

[moda0306]

To post based on my knowledge of miners is probably pointless, but I'd imagine that mining stocks have a lagging correlation with the price of gold in general, but are also affected by the macro-forces on the stock-market (especially the negative (2008) ones).  Given the fact that the overall stock market is back within reaching distance of its all-time high, if you don't think gold is in a bubble, it would appear miners would be a great VP play to make.

The problem is, the more difficult gold is to obtain out of the ground, the less the miners have any legitimate function, and therefore maybe the ratio will skew for legitimate reasons. 

[Wonk]

"Zeal Intelligence" (by Adam Hamilton) and "The Speculative Investor" by Steve Saville are two newsletters that cover this area pretty well.  

I like Saville.  Smart guy.  He had a nice article on the lack of Japanese inflation a while back:

http://www.gold-eagle.com/editorials_08 ... 72109.html

What's interesting about his analysis is that Japanese M2 growth averaged about 2% annually for 15 years.  Japanese inflation averaged 0% over the same time.  Given that new supply of above-ground gold averages about 2% annually over the long term, it's pretty easy to make the case that Japan has increased money at about the same rate annually as under a gold standard--which would result in 0% price inflation.  Current U.S. M2 growth is at 5% so we don't have the same problem...yet.  But nothing in the future is guaranteed, of course.  Things that make you go hmmmmm....

MT: Gold/XAU ratio.  Not sure we can make anything of it yet.  Could be on the verge of another liquidation.  Could just be mining shares are very undervalued relative to gold.  If you asked the B'head board, they'd tell you shares are priced right and gold will crash to $600. 

All I know is as new money comes in, it's going to mining shares for the time being.  I'll have the cat box ready if it hits 10+.

[HB Reader]

HB Reader,

Do you not think the contraction of credit by Americans is much more deflationary than the printing of money is inflationary?

Do you think that contraction will continue?

I take the deflation risk very seriously, but I believe the expansionary capabilities of the central banks in the world, led by the Federal Reserve, are more powerful than many observers believe.  They can't inflate away our problems, but we could see much more monetary depreciation before they (and more importantly the body politic in the countries that matter) make the calculation that, on balance, expansionary policies are more dangerous than contractionary ones.  I see no indication of that political calculation yet.

A deflationary wave might swamp the best efforts of the world's central banks (like what almost happened in 2008), but for the time being I'm willing to bet otherwise in my VP.  My guess is we will continue to muddle through, with increasing monetary instability, for several more years.

This judgment has no implications for my PP.  In my VP, I place my bets and take my chances.  I could change my opinion tomorrow.