Longtime readers know that we
are a fan of intermarket analysis. The movement of certain markets influences
other markets so it is always wise to analyze a handful of markets rather
than just a single market by itself. Several years ago we learned from others
before us how intermarket analysis can help us get a handle on the margins of
gold (and silver) miners. Generally, Oil (energy) represents about 25% of the
cost of mining while industrial metals prices can be a proxy for the costs of
trucks, chemicals and blasting agents (like cyanide). It has been a while
since we've looked at these charts but with the gold stocks having put in a
major bottom it is time to analyze whether it is sustainable or not.
Simply put, we look at Gold
relative to oil (bottom) and Gold relative to industrial metals (top). These
ratios were quite low in 2007 when share prices were driven more so by
positive sentiment and high valuations then by positive fundamentals. As you
can see, the financial crisis was a major catalyst for the gold mining
industry. Gold surged against oil and industrial metals. During the weak
recovery these ratios held their ground and are reaching higher levels once
again.
Next, we want to look at these
markets by themselves. Industrial metals prices are on top while oil is on
the bottom. Do these markets appear to be any threat to move much higher?
Industrial metals have substantial resistance at 500 and have made obvious
lower highs and lower highs in the past year. GYX is threatening a move below
350. Oil has also made lower lows and appears far more likely to test $78-$80
then to rebound above $95.
Meanwhile, Gold continues to
hold up quite well within a consolidation. Predictably, its rebound ended at
$1800. Yet, the market has a very strong bottom in place and has good support
just below $1700.
As you can see, according to
this simple straightforward analysis, Gold mining margins should continue to
expand. The commodities that represent mining cost inputs are not only
trending bearish but are little threat to move much higher anytime soon.
Meanwhile, Gold is trading in a healthy range and once it breaks $1800 will
be within a month or two of breaking to a new all time high.
In the early years of the
boom, gold stocks performed quite well even as cost inputs surged. The reason
was the market was willing to pay more and more for gold stocks. Presently we
have a very different situation. The fundamentals for gold producers are
improving yet the market is attaching low valuations to these companies. Our
view is that if Gold breaks to and sustains a new high then the current
valuations of these companies will increase materially.
All this being said, it is
important to understand that gold mining is an extremely difficult industry.
Despite this positive analysis, a fair portion of the industry will struggle.
It is geologically and mathematically impossible for major producers to grow
consistently. Small miners often lack the expertise and manpower to be
successful. Most are aware of the 80-20 rule. We just returned from a tour of
one of the best producer's projects. We heard that this management team
believes in the 95-5 rule. In other words, in the gold mining industry, 5% of
the people produce 95% of the profits. You should keep this in mind when
evaluating producers and potential producers. This is also why we focus on
stock selection. In this sector, it is crucial to achieving great returns.
Good Luck!
If you'd be interested in
professional guidance in uncovering the producers and explorers poised for
big gains then we invite you to learn
more about our service.
