The gold and silver stocks as
a group have certainly been a disaster over the past two years. Both GDX and
GDXJ are down with GDXJ leading the spiral. Yet, the metals are actually
higher. Gold is up quite a bit while Silver is up marginally. Because of the
volatility in this sector we can certainly choose any period to emphasize a
point. However, it is becoming clear that the mining equities are struggling
to outperform the metals. In studying the history of this sector (both the
stocks and the metals) I've learned two things that I will share with you
today. First, the large-cap miners have no track record of consistently
outperforming Gold and second, it is possible to routinely find companies
which can outperform the metals.
I credit the first point to Steve Saville,
who was one of the first to note that the miners do not consistently outperform
the metals. In fact, in secular bull markets the stocks consistently
underperform Gold. Steve's chart below shows how the miners underperformed
badly from 1974 to 1980. Recall that the Gold price was fixed until 1971.
Thus, both the uptrend from 1964-1968 and the downtrend from 1968-1971 are
exaggerated.
It is simply a function of
geology and numbers. Large companies have an extremely difficult time finding
enough deposits and big enough deposits to not only replace reserves but to
grow production. It's much easier for a company to grow from 50K oz Au
production to 100K oz Au production than it is for a company to go from 2M oz
Au production to 4M oz Au production. Throw in political risk, permitting
delays, financing issues and execution issues and its understandable why the large
companies underperform the metal. This being said, it's important to take all
those XAU vs. Gold charts with a grain of salt. Over the long-term, Gold will
continue to outperform and that chart will continue to make new lows.
Moving along, it is important
to examine the relative strength of various gold stocks in particular market
cycles. Below we graph the HUI versus Gold. We highlighted the performance
during cyclical bull markets. In all three examples we notice that the
biggest gains came at the start of the cyclical bull market. In the last two,
the bull market ended as the HUI/Gold ratio peaked slightly below its high
for the cycle. This tells us that the stocks will strongly outperform at the
start of the next cyclical bull but that outperformance will ultimately peak
or fade.
Next we move down the food
chain. For subscribers I created a 20-stock index which contains roughly the
20 biggest producers outside of the HUI. As you can see the price action
during this cyclical bear looks somewhat similar to the HUI. However, focus
your attention on the next chart.
Larger Image
This chart is the ratio
between the above 20-stock index and Gold. The ratio bottomed in late October
2008 and peaked in early December 2010. The increase in this ratio coincided
with the exact period of the cyclical bull market (if you count December 2010
as the end which I do). One could claim that the next problem is the above
index underperformed even as Gold was rising. That is true. Nothing is
perfect.
However, we took things a step
further. I thought of 10 of my favorite growth-oriented producers (royalty
companies included). Seven of the ten have been part of our model portfolio
at one time or another. Below is the chart of an equal weighted index of the
10 stocks. It was up 4% in 2011 and 42% in 2012!
Larger Image
Here are my conclusions on
this small study. The large cap miners will continue to underperform Gold
through the end of the bull market. However, they will outperform when the
next cyclical bull begins and probably soon. However, they ultimately will
underperform over the next five years. During a cyclical bull market a large
group of junior producers can outperform Gold strongly. You only need to be
able to pick the right large group. The better a stock picker one is, the
more one can outperform. Clearly, if you are stock picking this sector you
should never dabble in the large cap miners. If you want safety than go with
bullion and try to find a mutual fund that has a track record of picking the
right stocks. If you want to speculate than you need to train yourself to be
an excellent stock picker or find someone who can help you learn.
Interestingly, I believe the
near-term outlook is pretty good and most stocks have a chance to outperform
the metals into the spring. The caveat is we need to see a final breakdown
first. GDX, the HUI and my junior index above are all consolidating which
could precede a breakdown and the final low. Over the past 10 sessions, GDX
has been locked into a range of $41.50 to $43.00. A downside break, in your
humble author's opinion could lead to the final bottom which we wrote about
last week. Continue to be patient and continue to have your favorite stocks
in mind.
Good Luck!
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