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Recently, the Erste Group
published a 120 page
report covering precious metals. The report contains an absolute treasure of analysis, figures and charts concerning gold and the gold stocks. I have selected a few of the charts which help us explain the current status of the gold stocks. Essentially,
there is a huge divergence between financial performance and valuations.
Ultimately, the performance of the shares over the coming months will answer
the question as to the resolution of that divergence.
We often hear how difficult of a time some mining companies
are having. Although that is true,
the reality is present
conditions for gold miners have never
been better. Rising costs are a problem
but margins for the large unhedged
producers are at bull market highs (and likely all-time highs).
The rising margins explain the consistent increase
in cash flow and net income
(with a few bumps) as the
chart below depicts. Cash flow and net income for 2012 will also reach a bull market high.
Given the high margins,
cash flow growth and
record earnings why are
the stocks struggling and trading
well off their highs? A major and often forgotten explanation is the current low valuations. Several months ago, the price to cash flow valuation of senior producers was equivalent to valuation lows seen in
2000 and 2008. No chart better
illustrates valuations then this one from BMO Capital Markets.
 
Now let’s
examine the current technicals
and draw a comparison between today’s bull market and the bull market from 1960 to 1980. Below we plot the current bull market in the HUI (red) and the
Barron’s Gold Mining
Index (BGMI). There are some differences
but also some similarities. Note that the level 170 was key support and resistance for the BGMI for nearly
five years. Once the Bgmi
broke 170, it was headed much
higher.
One can better view
the current key pivot point from
the chart below. The
52-55 range has been key support and resistance for
GDX since late 2007. If
and when GDX makes a weekly close above 55, you can bet that
the prognosis will look quite bullish.
The market is at
an interesting crossroads.
Financial results have been strong
but valuations are weak.
The market believes earnings and cash flow will decline and has priced in that outcome to some degree. Ultimately, this will resolve
itself in one of two ways. Producer margins can decline which
would impact cash flows
and profitability. That would
eventually lead to lower share prices and GDX could threaten a break below 40. On the other hand, should margins increase then share prices will explode higher from a compounding effect. Rising margins will generate stronger cash flow and higher profits and the low valuations will rebound as sentiment would normalize. This is the fundamental case for the next
major breakout in the gold shares.
Given the technical
damage from the recent selloff (which went a bit further than expected) one should not anticipate this crossroads to be resolved anytime
soon. Think months rather than days or weeks. Ultimately, the shares will break 55 to the upside in 2013 thanks to the combination of a breakout in Gold combined with stable costs in 2013. In the meantime the shares
will consolidate providing you time to do your research and find the companies that will lead the next leg higher
and outperform. 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.
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