Overview
The past few years have been lousy for gold and related equities with few
exceptions. Gold miners have been hit especially hard, as they’ve been
impacted by more than just falling gold prices. Production costs have risen.
Political risks have suspended several outstanding projects. Capital has been
much more difficult to come by as investors expect the gold price to fall
further. As a result, over the past five years while the gold price is
roughly flat the Market Vectors Gold Miners ETF (NYSEARCA:GDX) has lost 58% of its value.
There are a lot of gold miners out there and not all of them have faced
these problems. In fact some of them have improved their positions
substantially in the past 5 years. Unfortunately, bear market selling is
indiscriminate, and many of these companies’ stocks were overvalued in 2011.
Investors who locate such opportunities will find that they are often very
inexpensive due to this indiscriminate selling.
Assuming gold hasn’t bottomed we could very well see another round of
heavy indiscriminate selling. But I think some gold stocks have bottomed and
are in clear uptrends. Some of them are cheap companies that are rapidly
growing their fundamental valuations through asset accumulation and
optimization, asset divestiture, and with a little bit of luck: deposit
discovery and expansion. These companies are poised to benefit tremendously
from the next leg of gold’s secular bull market–an event that is all but
inevitable, albeit impossible to time.
Before assessing gold miners and strategies for owning them it is
important to know the reasons to be long of gold generally. I will get to
mining companies in part 2.
Why Gold?
Gold has been in a relatively clear downtrend since 2011, although it is
in a much longer uptrend and it trades at multiples of its 1999 bear market
trough of $255/oz.
(Source: Strategicgold.com)
Money supply isn’t the only factor that impacts the gold price or the
Dollar’s purchasing power (demand for money is the other factor) but over the
long-term it is a very good indicator.
Conclusion
Will we see a bottom in 2015? I don’t know, but I think the risk/reward is
heavily skewed towards gold bulls and against the bears. In order for gold to
reflect the rise in the global money supply we’ve seen over the past several
years it would have to rise substantially. I think we will see not just a
mean reversion but an overshoot, so that market euphoria creates a situation
in which gold is overvalued relative to the money supply, and since gold is
cheaper than it has ever been relative to the monetary base the overshoot
could be more substantial than it was in past gold bull markets.
How high is this? Consider that in the 1970’s bull market the value of the
U. S. gold hoard peaked at 5X the monetary base, or nearly 20X the current
ratio, meaning that if gold were to hit the same peak we could easily see
$20,000/oz. gold or higher.
The downside would have to be considerable, and considerably likely, if
this reward weren’t worth pursuing. Since gold is already inexpensive
relative to the monetary base and to other data points (e.g. the cost of
production) it is difficult to imagine any more downside fundamentally.
Nevertheless the gold market is making lower highs and lower lows while
risk-free interest rates (i.e. Treasuries) are still incredibly low, making
many stocks and bonds attractive on a relative basis. This is a status quo I
want to bet against longer term, but it is impossible to know concretely what
will shift the market direction and when this will happen.
I don’t think we will see gold trade below its 1980 high and strong support
level of ~$850/oz. I know it sounds like a long fall from $1,200/oz. but
relative to the upside it is tremendous. Furthermore this is a worst-case
scenario and a price we might only see for a few hours or days. The low might
be $1,000/oz., or it might already be in.
This article first appeared at MiningWealth.com
on May 26th, 2015.
