If You Haven’t Participated in Gold’s Recent Rise – Don’t Fret – The Fun Has Only Just Begun
23 different countries are currently participating in a currency devaluation “race to the bottom” … and…as investors who seek safe harbor in hard money… we’re content to own precious metals investments until such a day arises when the currency war winner is finally announced – and we expect dramatic increases in such investments by the end of the first quarter of 2011. As such, if you have not participated in gold’s recent rise – don’t fret – because NOW is the time to climb on board! Words: 1072
So says Sprott Asset Management (www.sprott.com) in an article* which Lorimer Wilson, editor of www.munKNEE.com, has reformatted into edited […] excerpts below for the sake of clarity and brevity to ensure a fast and easy read. (Please note that this paragraph must be included in any article reposting to avoid copyright infringement.) They go on to say:[We are not alone in that regard, however, as many other investors are also] shifting capital to protect themselves. A large number of commodities are now benefitting from the uncertainty created by the devaluation race. Gold, silver, oil, copper, wheat, sugar and platinum are all on the run, and yet we have no reported inflation! Kudos go to the Central Banks for orchestrating that economic miracle. Nonetheless, regardless of what the CPI says, it’s clear that investors are proactively preparing themselves for more printing, and gold and silver (see more here) seem to be the most popular choices for investors seeking safe harbor.
Senior Gold Producers Present a Major Investment Opportunity
While gold and silver bullion increased by 24% and 47%, respectively, during the first 10 months of 2010 gold stocks as represented by the Market Vectors Gold Miners ETF (GDX), the Philadelphia Gold and Silver Index (XAU), the NYSE Arca Gold Bugs Index (HUI) and the S&P/TSX Global Gold Index have all trailed gold’s performance. You wouldn’t expect the senior gold producers to be trailing behind gold in this environment. After all, at $1,300 – $1,400 gold, these companies literally have a license to print money. What better business is there to be in right now? These are companies that can process an ounce of gold for $800 and sell it for $1,300- $1,400, with virtually no sales risk. What other investment sector can boast that kind of margin in this environment?
We believe the gold producers present an excellent investment opportunity right now. To explain why, consider the NYSE Arca Gold Bugs Index (HUI). The HUI is a modified equal-dollar weighted index of companies involved in major gold mining. The HUI was designed to give investors exposure to near-term movements in the gold price by focusing on companies that do not hedge their gold production beyond 1.5 years. The HUI was launched with a base value of 200 in March 1996 and includes some of the largest gold mining companies in the world…The current HUI valuation doesn’t reflect the operating leverage that the $262 increase in the spot gold price since the beginning of the year could potentially have on earnings – which brings us to an important point that investors often overlook in gold stocks.
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Because of the nature of gold mining’s fixed costs, any increase above the total cost per ounce significantly increases a gold producer’s net income on a percentage basis. Consider a hypothetical gold producer with cash costs of ~$500 per ounce, which is around the industry average. At $1,000 gold, this company generates an EBITDA of $500 per oz per ounce mined. Simple enough. But most mining companies have extra costs on top of their operating expenses. For a new gold project these extra expenses will typically add another $300 or so per oz. So for every ounce mined, our gold mining company is now only generating $200 of margin based on 2009 input costs and $1,000 gold. With $1,350 gold, however, and the same cost structure of $500 in operating costs and $300 in additional costs, our hypothetical gold company has now increased its margin from $200 to $550 an ounce, representing an increase of 175%! We don’t believe current gold equity valuations reflect this potential margin increase at all, but they soon will. A re-rating is just around the corner.
Now is the Time to Own Gold Stocks
The bullish case for gold stocks is even more compelling if you consider the historical trend going back to 2000. Chart B plots the HUI index in gold terms. When this ratio is rising, it means that gold companies as measured by the HUI are outperforming gold. Conversely, when this ratio falls it means gold is outperforming the HUI. As you can see, the recent relative underperformance to gold is not in line with the historical trend. Chart B illustrates that gold stocks are currently trading at the same relative valuation they did when gold was priced at $313/oz! We were investing in gold stocks in 2003 and did not find them to be rich in valuation. We believe this discrepancy indicates that gold stocks have a ways to appreciate in order to match the underlying metal’s recent performance.
For those readers who are more technically inclined, the HUI Index chart is signaling a very bullish uptrend. Technical analyst Ross Clark from CIBC Wood Gundy forecasts the HUI going to the upper 800s from its 522 at the end of October representing an increase of approximately 70%!! Frankly, it is very rare to have fundamental and technical analysis align to predict such a strong move in an equity sector.
One of the best and painfully obvious axioms for investing, but so often forgotten by seasoned investors, is that it is all about earnings. Earnings are what drive stock prices over the long term… and we can’t think of a single equity sector that exhibits better year-over-year earnings growth potential than the gold producers. Despite the buzz you’ve heard about gold and silver over the last two months, the stocks haven’t caught up. We expect that to change over the next two quarters as investors realize how much stronger gold producers’ earnings will be at $1,350 [to $1,400] gold (see more here).
As countries decide to burn their currencies in the devaluation race, gold has responded.
It is now the gold producers turn to perform.
- The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
- Permission to reprint in whole or in part is gladly granted, provided full credit is given as per paragraph 2 above.
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