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--- by Vedant Mimani
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With gold currently trading around $1200 per ounce — an increase
of almost five fold from 2001 — it is only natural to wonder how much
gas is left in this tank. The fact is, we don’t know and we sort of
don’t care. We’ve said it before and we’ll say it again:
the real opportunity for wealth creation in the years ahead lies in the
business of gold mining.
The world is in the midst of a credit contraction, of the kind that always
follows credit expansions. We have found from historical study that these
contractions in credit tend to run for about twenty years. During every
single prior credit contraction, the real price of gold, as measured against
all commodities and assets, had increased. This increase in the real price of
gold represents expansion in profit margin for the gold mining industry.
The last major credit contraction occurred during what we now refer to as the
Great Depression. During that time, gold miners such as Homestake
Mining were among the few companies to reward its shareholders. The Financial
Crisis of 2008 stayed true to form. Starting September 2008, gold once again
has started to outperform all commodities and assets.
It may seem counterintuitive that gold mining represents the best wealth
creation opportunity over the next several years. After all, in 1971, the
price of gold was $35 per ounce. An investor could have bought gold bullion
in 1971, buried it in the backyard, and have a thirty-five fold return and
counting as of today. Yet despite the price of gold increasing thirty-five
fold over the last four decades, gold mining itself has been mostly a crummy
enterprise in terms of all basic business metrics during that period. This is
simply because the input costs increased faster than the price of gold,
resulting in little to no profit margin for the industry as a whole.
That all changed in September 2008 when private credit growth peaked. Since
then, the price of gold has increased steadily, while the costs of mining
gold have decreased significantly; the real price of gold, as measured
against all commodities and assets, has increased. Today large cap miners
have robust 40%+ operating margins as they are benefiting from the increase
in gold prices relative to the costs to mine gold. A quick glance at the last
two quarters of operating results for the major miners shows that the
increase in the real price of gold is resulting in strong financial
performance. As far as we are concerned, we are only two years into a twenty
year trend. It’s not late; it’s early early
early.
Are gold miners cheap right now? Examination of gold miners on traditional
metrics such as price to net asset value or price to book value, reveals that
the miners as a whole are not underpriced on an as-is basis. This is not a
“buy $1 for $0.80” type story. Gold mining today is a value
creation play in which the macro variables, increased real price for gold and
decreased input costs, have aligned and the sector is now experiencing a
tailwind instead of a headwind. When the real price of gold increases
linearly, mining profits are likely to increase exponentially.
From March 2009 through mid-April 2010, gold and gold miners have
underperformed most other asset classes. In the second half of April 2010, we
witnessed a turn from relative weakness to relative strength in gold and gold
mining shares. Gold miners are the new leaders and have once again started to
outperform all asset classes. In May alone, gold miners outperformed the
S&P 500 by 9.5% (as measured by the Gold Miners ETF, GDX, versus S&P
500 SPDRs, SPY). The real price of gold is now never looking back; but from a
technical perspective, in the short term, gold’s relative strength is
overbought and may need some time to work this off.
In conclusion, whether we have deflation, inflation, or pick your favorite
‘flation, we ought to remember
history’s record that in a credit contraction, the real price of gold
increases relative to all commodities and assets. This increase in the real
price of gold results in margin and profit expansion for gold miners as the
spread expands between the price of gold and the cost to mine gold. Gold
mining will be one of the few, if not only, sectors to enjoy this type of
tailwind in the years ahead.
The last cycle’s mega fortunes were made mostly in real estate,
computer technology and finance. Tomorrow’s mega fortunes will be made
mostly in gold mining. Of course, the road from here to there will continue
to be volatile and laden with pitfalls, but the trend remains our friend.
About the author: Vedant 'VK' Mimani is the founder of Atyant Capital, a macro fund in Boca Raton, Florida focused on precious metals.
Toni Straka
Editor,
the Prudent Investor
Toni Straka
is an INDEPENDENT
Certified Financial Analyst (OeVFA, EFFAS) who
worked as a financial journalist for 15+ years and now evaluates global
market trends. Analyzing financial and political news permanently he wants to
share his insight with those who understand that we are in an era of global
redistribution of wealth. The US-European centric approach does not work
anymore. Five billion people in the developing countries now demand their
fair share of the world's resources.
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