|
Gold stocks languish in a sentiment wasteland these days, left for dead
by everyone but a small contrarian remnant. So naturally bears abound, their
arguments dominated by the idea that gold miners’ costs are so high
that they can’t make money anymore. Provocatively though, this notion
is totally wrong. As gold-stock valuations reveal, gold miners are earning
profits hand-over-fist at today’s gold levels.
Valuations are the fundamental
heart of stock investing, ultimately driving the vast majority of
long-term performance. Investors buy stocks because they want a stake in
companies’ future profits streams. The less they pay for each dollar of
future profits, the better their ultimate returns. And the price of future
profits is a direct function of prevailing stock prices. Valuations measure
how much profits cost.
The classic price-to-earnings ratio has always been the leading valuation
metric. P/E ratios are simple in both concept and calculation. Any
company’s stock price is divided by its latest annual profits per
share, yielding the amount that investors are being asked to pay for each
dollar of earnings. The resulting ratios are often expressed as “times
earnings”. A stock with a P/E of 30.0 is said to be at “thirty
times earnings”.
In this case investors must pay $30 for each $1 of yearly profits. But
what if they could buy $1 of earnings for just $20 or even $10 elsewhere?
Every dollar is fungible, right? A dollar an investor makes in stock XYZ is
no better or worse than a dollar made in ABC. So over time investors
naturally gravitate to sectors with lower P/E ratios. Investing is about
paying the lowest-possible price for the highest-possible profits.
Sectors with low P/E ratios attract value investors seeking to do exactly
that. And traditionally gold stocks are certainly not a value realm. For most
of their secular bull, they had high valuations. Investors were paying a
premium for the earnings the gold miners could spin off. Why? They believed
that gold’s bullish
fundamentals would force the metal higher, greatly increasing gold
miners’ earning power.
And that indeed ended up being one of the best bets of the last decade.
While gold’s secular bull propelled it 638% higher at best between 2001
and 2011, the flagship HUI gold-stock index blasted an astounding 1664%
higher at best by last September. This performance is epic, as over the same
secular span the benchmark S&P 500 actually fell 14%. The gold
stocks have leveraged gold by 2.6x so far.
With gold stocks exploding nearly 18x higher
during a secular bear
where the stock markets were flat, they should be the most popular
sector on the planet today. But their recent serious correction of 41% over
eight months as measured by the HUI has totally obliterated bullish
sentiment. The bears have tried to rationalize these losses as the new normal
(as opposed to a temporary selloff) by attacking earnings.
They claim gold stocks are doomed to drift even lower indefinitely
because the rising costs of gold mining are rapidly eroding profits. And the
lower the earnings gold stocks as a sector can generate, the lower their
stock prices should be as investors refuse to overpay for future profits
streams. Thankfully because earnings are one of the most important and
widely-followed stock metrics, this idea is easy to investigate.
At Zeal we’ve been tracking and analyzing gold-stock earnings for
over a decade now. I wrote the original essay in this series way back in May 2004. While P/E ratios are calculated on an
individual-stock basis, they can be aggregated to give valuation reads on
entire sectors. The best way to do this is to pick a major stock index and
calculate a weighted average of the individual P/Es
of all its component stocks.
In late 2006 we started doing this for the HUI. At the end of every month
we record each HUI component’s stock price, P/E ratio, dividend yield,
and market capitalization. We feed this all into a giant spreadsheet that
computes a bunch of stuff including the HUI’s
market-capitalization-weighted-average P/E. That is a mouthful, but weighting
index component P/Es by market caps is essential
for precision.
Say you had a hypothetical index of two gold stocks. One has a P/E of 90
and the other a P/E of 10, so their simple-average P/E would be 50. But what
if the expensive former stock has a market capitalization of $3b while the
cheaper latter one is worth $30b? Investors have 10x more capital at risk in
it, so it should be weighted accordingly. Their MCWA P/E is 17x, a superior reflection of underlying reality.
This first chart documents the HUI component stocks’ MCWA P/E
ratio, simple-average P/E ratio, and dividend yield at the end of every month
since 2007. If the bears’ thesis is right, that gold
miners’ profits are shrinking as higher costs eat up operating cashflow, it would absolutely show up in these valuation
metrics. Lower earnings would yield higher P/Es,
but the exact opposite is true. The bears are wrong.
Gold-stock P/E ratios today are actually the lowest they’ve been in
this entire secular bull. Our latest read at the end of May saw the HUI sport
an incredible MCWA P/E ratio of only 12.0x earnings. This is amazingly cheap
for gold stocks as this chart shows, way below even stock-panic levels. Gold
miners are actually earning enormous profits now relative to their stock
prices. They are value investments today.
Zooming way out, the general stock markets meander in great
third-of-a-century cycles I call Long
Valuation Waves. At the crests of these waves just before major
secular bears (like in early 2000), stocks tend to trade above 28x earnings.
By the troughs about 17 years later, general-stock-market P/E ratios have
fallen near 7x earnings. The long-term average of the broad-market P/E ratio
is around 14x.
So in an absolute sense, gold stocks (which traditionally have high P/Es like growth stocks) are now trading on the cheap side.
At the end of last month, the broad S&P 500 MCWA P/E was running at 17.8x. I never thought I’d see the day, but gold
stocks are far cheaper than the stock markets as a whole. A dollar of
gold-stock profits costs investors $12, but the same dollar is going for $18
in the general markets.
As recently as early 2008, which was before that epic once-in-a-century
stock panic, investors were happily paying 40x earnings for gold
stocks. While certainly expensive, the idea was that as gold powered higher
gold miners’ profits would rise and their valuations would fall. And
indeed this has been the case for most of this secular bull, as the downtrend
shown above in the HUI’s MCWA P/E reveals.
By the time the HUI fully recovered from its brutal stock-panic losses in
late 2009, its P/E ratio had been cut in half. Even though gold stocks were
trading at similar levels to early 2008, their profits had effectively
doubled so their valuations were much lower. And by summer 2011 as gold
stocks powered to new all-time highs, their valuations shrunk lower still.
Gold miners’ profits just keep on growing.
And this is not just relative to stock prices, which valuations measure.
It is also true in an absolute sense as my business partner Scott
Wright’s ground-breaking research
shows. Between 2007 and 2011, average profits at nearly two dozen of
the world’s largest gold miners (representing almost half of global
mined production) soared dramatically from $354 per ounce to an astounding
$915 per ounce.
Even though mining costs are rising rather sharply as the bears gleefully
latch on to, profits and even profit margins are rising faster. The strong
ongoing secular bull market in gold is more than offsetting the growing
challenges of wresting this scarce metal from the bowels of the earth. Gold
mining has become so profitable that the gold miners are even dramatically ramping their dividend payments to investors.
The yellow line above shows the MCWA dividend yield of the HUI component
stocks. It is multiplied by ten so it can use the same P/E axis, so 15 means
1.5%. Notice that gold miners have been raising their dividends consistently
for a couple years now. This along with the sharp capitulation plunge in this
sector’s latest correction has led the HUI’s dividend yield to
surge. It is now way up above 1.8%.
Dividend yields are another valuation metric that works the opposite of
P/E ratios, high is cheap and low is expensive. For most of 2012, the
HUI’s dividend yield has actually been higher than it was during that
extreme stock-panic anomaly in late 2008. Dividends are the ultimate acid
test of earnings, because companies can’t pay them unless they are
earning way more than necessary to cover these cash outflows.
So gold-stock dividend yields are way above panic extremes while
gold-stock price-to-earnings ratios are way below. By both of these standard
valuation metrics, gold stocks are now as cheap as they’ve been for
their entire decade-plus secular bull. This unloved and forgotten sector has
seen its stock prices beaten so low that it is now a value play today,
something literally unheard of in the gold-stock world.
When the bears assert that gold stocks’ earnings are falling,
realize they are either lying or too lazy to do the research themselves.
We’ve spent nearly a decade building extensive databases of gold-stock
earnings, and their trend is crystal-clear as this chart shows. Gold
stocks’ brutal correction since September’s latest peak was a
sentiment thing, driven by fear. It had nothing to do with fundamentals.
Traditionally in this series of essays on gold-stock valuations,
I’ve included an alternative valuation measure to buttress the case
argued by P/E ratios and dividend yields. It looks at the HUI relative to the
gold price, which ultimately drives gold-stock profitability as a whole. As I
discussed this HUI/Gold Ratio in depth in another thread of research last
week, I won’t dig in deep today. But it is important to consider.
Relative to the gold price which drives their profits, gold stocks were
recently bludgeoned back down to 2008’s stock-panic levels. But such
extreme under-valuations couldn’t persist then and they won’t
persist today. Gold stocks need to and will rebound sharply to reflect
today’s prevailing gold prices. Even if gold goes nowhere, the HUI
would have to nearly double just to regain its five-year pre-panic HGR
average.
So this nontraditional valuation metric of the HUI/Gold Ratio totally
agrees with what the classic P/E ratios and dividend yields are screaming.
The gold stocks are dirt-cheap today, radically undervalued relative to the
profits that gold mining is spinning off. Sooner or later this gold-stock
pricing anomaly is going to catch the attention of value investors, and
capital will flood in to buy this sector’s future profits cheap.
If you can buy a dollar of annual future profits in elite gold stocks for
$12 today, why pay $18 for the same dollar in the general stock markets? The
earnings stream of gold stocks is a third cheaper, which is unheard of for
this sector that traditionally trades at high valuations. Prudent investors
want the biggest bang for their hard-earned dollars, the best value, and gold
stocks are offering that in spades these days.
Like the rest of the markets, sentiment flows and ebbs in the gold
stocks. Sometimes investors love them and bid them up to dizzying heights as
greed reigns. But then the great sentiment pendulum starts swinging towards
the opposite extreme of fear. And gold stocks are crushed to ridiculous
unsustainable lows like we saw last month. Realize neither
excessive greed nor excessive fear can persist for long.
And once sentiment inevitably shifts, it won’t take much capital to
drive massive gains in this tiny sector. As of the end of last month, the
total market capitalization of all the HUI’s component stocks was under
$182b. Meanwhile the biggest stocks of the general markets as measured by the
S&P 500 were worth $12,394b. Worth less than 1.5% of the broader markets,
the small gold-stock sector can easily rocket.
The only real threat to this bullish gold-stock thesis is the price of
gold, but for a wide variety of reasons its secular bull is likely to
continue gradually powering higher. And the higher the gold price, the higher
the gold stocks will ultimately be bid. The goofy Federal Reserve continues inflating the narrow and broad money
supplies in the US like there is no tomorrow, and
fiat-money inflation is gold’s best friend.
The Fed’s latest data shows it has grown the broad MZM money supply
by an absolute 8.3% over this past year. Meanwhile the global gold supply
grows by a fraction of that from new mining, on the order of 1% annually over
the long term. With relatively more dollars available to chase relatively
fewer ounces of gold, it’s hard to imagine gold’s secular bull
giving up its ghost anytime soon. Couple this with extreme uncertainty
heading into November’s critical US elections, and gold should thrive
in the months ahead.
So today’s beaten-down gold stocks are an incredible fundamental
bargain. They are super-cheap relative to their earnings, dividends, and the
price of gold which drives their performance. We’ve never seen such a
confluence of extreme undervaluation in this entire secular bull, so
speculators and investors strong enough to fight the crowd and buy low have
one of the best buying ops of this bull today.
And among the gold stocks, none have been hammered harder and lower than
the junior golds. Their upside potential vastly
exceeds that of the HUI’s major miners. We are constantly researching
this realm, which includes many hundreds of publicly-traded stocks. The great
majority are junk, doomed to fail. But the rare winners will prove wildly
successful and earn vast fortunes for the investors who buy in early.
We just finished our latest deep-research project on this front last
week. We gradually whittled hundreds of these companies down to our dozen
fundamental favorites, which we profiled in depth in a fascinating new
27-page report. It
is now for sale for just $95 ($75 for subscribers), a fantastic deal for
hundreds of hours of expert world-class research.
Buy yours today,
and get deployed before junior golds surge.
We also publish acclaimed weekly and
monthly subscription newsletters loved by
speculators and investors worldwide. In them I draw on our vast experience,
knowledge, wisdom, and ongoing research to explain what the markets are
doing, why, where they are likely heading, and how to trade them with
specific stock trades as opportunities arise. Subscribe today, and grow your knowledge
and success!
The bottom line is gold-stock valuations are incredibly low today. In
fact, they have never been lower throughout this entire decade-plus secular
bull. Despite all the bearishness and pessimism out there, gold miners are
practically minting money at today’s high prevailing gold prices.
Profits are very high both absolutely and relatively, and high dividend
yields irrefutably confirm these high cashflows.
So it is not fundamentals that have been plaguing gold stocks, but
psychology. Traders are scared because gold stocks have corrected sharply.
This always happens after major selloffs. But this very fear paves the way
for massive uplegs as sentiment slowly swings to
the opposite greed extreme. As that shift accelerates, gold miners’
high profits will attract in more and more investors as gold-stock prices
surge.
Adam Hamilton,
CPA
June 25, 2012
So how can you
profit from this information? We publish an acclaimed monthly newsletter, Zeal Intelligence, that details exactly what we are doing in terms of
actual stock and options trading based on all the lessons we have learned in
our market research. Please consider joining us each month for tactical
trading details and more in our premium Zeal Intelligence service at … www.zealllc.com/subscribe.htm
Questions for
Adam? I would be more than happy to address them through my private
consulting business. Please visit www.zealllc.com/adam.htm for more information.
Thoughts,
comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I
regret that I am not able to respond to comments personally. I will read all
messages though and really appreciate your feedback!
Copyright 2000
- 2012 Zeal Research (www.ZealLLC.com)
|
