A few years ago (when the world was very different) veteran mining analyst Jay
Taylor told me something that seemed counterintuitive: Deflation can
actually be a good thing for the gold and silver mining business -- if the
prices of mining inputs like oil fall faster than the price of precious metals.
In other words, it's not inflation or deflation per se that matter, but the
distribution of price trends. "With quantitative easing," said Taylor, "the
liquidity being pumped into the system has caused energy and labor costs to
rise, which has more than offset higher precious metals prices. Historically,
the miners have actually done better in a deflationary environment in which
gold and silver are seen as monetary metals and the cost of getting them out
of the ground declines due to lower energy and labor."
So the relationship of gold to the rest of the commodities complex is a good
indicator of the mining environment. Gold might be down, but if it's relatively strong,
the mining equation is favorable. How is it today? Improving:
This implies that the cost of mining gold is falling while the price received
for each ounce of gold is rising slightly. So margins, which have been squeezed
to the point of evaporation for even high-quality miners, might be less horrendous
than the markets now expect and (assuming current trends continue) earnings
in the second quarter and beyond might exceed expectations. With mining stocks
beaten down to historically-low levels, even stable earnings might be enough
for a nice rally.
