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Gold miners�’ stocks have been brutalized this
year, leaving them bleeding in the gutter as the most hated sector in all the
markets.Plunging prices always lead to fear and excessive bearishness,
unsustainable anomalous extremes that investors desperately try to
rationalize as righteous.Today the bears�’ primary rationalization against gold miners
is the notion they can�’t earn any profits, which is a complete fallacy.
Stock prices have always
been the result of an endless tug-of-war between fundamentals and
sentiment.Fundamentals measure how much any stock is worth based on its
underlying company�’s earning power.Naturally this only changes slowly, so stock prices
would be very stable and gradual if fundamentals were their sole
driver.Imagine a price chart with a largely-straight line, trending modestly
higher or lower.
But sentiment, traders�’ collective greed and fear,
endlessly forces stock prices above and below their slowly-evolving
fundamental reality.Visualize a sine wave oscillating around that core fundamentally-determined
price line.Buying buoys prices higher than fundamentals warrant, spawning
greed which feeds on itself.And fear hammers prices below that line, sparking
fear which becomes a vicious circle.
At the greedy crests of this price sine wave, traders are optimistic,
complacent, and even euphoric.Rather than acknowledge that prices are indeed
high after a powerful upleg, the ideal time to sell, they attempt to
rationalize those high prices as being the new norm.They latch on to any
theses that argue the high prices are actually fundamentally-righteous, no
matter how weak or tenuous those ideas happen to be.
The opposite happens at the fearful troughs of these price sine waves,
traders are pessimistic, scared, and even despairing.But instead of realizing
prices are very low after a wicked correction, the best time to buy, they
instead wrongly assume those low prices are fundamentally-righteous.So they
desperately look for any bearish theories that rationalize their fears, that
justify their overwhelming desire to sell low.
That�’s what is going on in gold stocks today.At worst in late June,
the flagship HUI gold-stock index had plummeted a gut-wrenching 53.4% in
2013 alone!And this year�’s carnage cascaded after a 16-month
correction where this gold-stock index had already lost 30.0%.Such extreme
price weakness ignited epic and universal fear, and the longer these low
prices persisted the more investors tried to rationalize them.
The word rationalize means �“to devise self-satisfying but
incorrect reasons for one�’s behavior�”.And that is exactly what
happens at price extremes.Investors know intellectually that they have to
buy low then sell high to multiply their wealth in the markets, but this
simple concept is so hard to execute.It requires fighting your own heart,
overpowering and ignoring your own greed and fear to buy and sell when you
least want to.
Today gold stocks as measured by the HUI are still down an astounding
51.4% year-to-date, and 66.0% in the 25 months since the HUI�’s all-time
record high.Gold stocks have never been cheaper relative
to gold, the metal that drives their profits and hence ultimately stock
prices.The HUI now languishes at levels it first hit fully a decade ago when
gold and silver were merely trading near $385 and $5.25, vastly lower than
today�’s prices!
Yet rather than acknowledging these simple absolute truths and agreeing
gold-stock prices are far too low today, that the popular fear
plaguing this sector is wildly overdone, the great majority of investors are
trying to rationalize these gold-stock levels as the new norm.They lack the
necessary contrarian courage to buy low, to fight their own fear.So they
create and traffic in theories that attempt to justify their own
bearishness.
Chief among them today is the widespread notion that gold miners can�’t
earn any profits.I get dozens of e-mails a week explaining to me why the gold
stocks are doomed to fall much lower because they simply can�’t earn
sufficient money where gold is today.After having spent 14 years studying the
markets full-time and trading gold stocks, the sheer popularity of this
notion blows my mind.It is completely and utterly false!
Investors desperately want to believe their own fears are justified, that
they are not fools for selling low or refusing to buy low.So they troll the
internet until they find someone even more irrationally bearish than them,
and then parrot his ideas.They can�’t be bothered with investigating
these theses themselves, instead they just blindly accept them as gospel
truth because they are emotionally in line with their own bearish biases.
But the cold, hard data is crystal-clear, gold miners can and are making
huge profits even in this year�’s horrendous gold environment.This is
readily evident in elite gold miners�’ price-to-earnings ratios.We�’ve
been building gold-mining databases for over a decade now at Zeal, and have
extensive earnings data.At the end of every month for example, we record the
P/Es of all the major gold miners in the HUI index.
Its 16 component stocks include the biggest and best globally-diversified
gold miners on the planet, which account for well over a third of
total worldwide mined supply.If gold miners indeed weren�’t earning
money, it would quickly show up in their individual P/E ratios.Yet even in
the midst of 2013�’s incredibly-anomalous gold plunge, the gold miners
are still showing their best profitability of their entire secular bull!
This first chart looks at two different measures of gold-stock P/E ratios,
taken and averaged monthly from the HUI component companies.The light-blue
line is the simple average of each gold miner�’s trailing-twelve-month
P/E ratio.The dark-blue line weights these P/E ratios by the market
capitalizations of each company, which in most cases is a more accurate
representation of an index�’s underlying valuation.
Price-to-earnings ratios are the core valuation metric for the
entire stock markets, and naturally lower is cheaper.Investors buying
stocks trading at 10x earnings, which means their current stock price is 10
times its profits earned in the last four quarters, have vastly higher odds
of seeing their stocks rally than if they buy at 30x earnings.The cheaper
this valuation multiple, the better the deal any stock price offers.
In both simple-average and market-capitalization-weighted-average
terms, the gold-stock valuations have been trending lower throughout
the HUI�’s entire monster 1664% 10.8-year-long secular bull.And today
both measures are as low as they�’ve ever been since at least November
2000 when this gold-stock bull was born in fear and despair.Gold-stock prices
have never been cheaper relative to their underlying profits!
With fear and despair again rampant in gold stocks today, every day I get
e-mails telling me gold miners can�’t earn enough anymore.That bearish
rationalization is incredibly popular, yet complete crap.People tell me gold
mining is now too expensive and gold prices are too low, so therefore it is
wise to remain very bearish when everyone else is after the second 70%ish mega-correction of
this secular gold-stock bull.
I always wonder if these people have no web browsers.Can�’t they
spend an hour on Yahoo! Finance to look at major gold miners�’ earnings
for themselves before they parrot some fool perma-bear�’s self-serving
falsehoods?I suspect many of these same investors were euphoric and bullish
in March 2008 and September 2011, when the HUI was carving major interim
highs.They offer some damning comparisons.
At the end of March 2008 in which the HUI hit 515, a whopping 139% higher
than today�’s levels, its elite component gold miners had simple-average
and MCWA P/E ratios of 38.2x and 34.8x earnings.And since these stocks had
been rallying and prices were high, investors eagerly rushed to buy.At the
HUI�’s latest September 2011 peak when it was 194% higher, these
valuation metrics were 29.4x and 21.1x.
Now remember higher valuations mean lower earnings relative to
prevailing stock prices.At the end of June 2013 after this year�’s
gold-stock plunge, the HUI components�’ aggregate P/E ratios were merely
17.9x and 11.3x, secular-bull lows even exceeding the extremes of
2008�’s hyper-fearful stock panic.If gold miners indeed couldn�’t
earn money today, their P/E ratios would be very high instead of
exceedingly low!
In about half the feedback I get parroting these silly bearish
rationalizations, the writers cite energy prices.They tell me gold mining
isn�’t profitable today because energy is so expensive, and gold mining
is usually very energy-intensive.In late June 2013, oil was around $97 per
barrel.Back in March 2008 and September 2011 at the last major HUI highs, it
was near $109 and $89.Gold stocks still soared despite high oil!
There�’s another key valuation metric to consider as well, dividend
yields.Dividends are the acid test of earnings, companies can�’t
pay them unless they really are earning the necessary profits to cover
them.Note above that gold-stock dividend yields (yellow) have never been
higher than they were this year, surging above 3% in June as the HUI slammed
into its lows.High dividends are a sign of financial strength.
Provocatively there is indeed a problem with gold-miner earnings today,
but it isn�’t them not making money.In the second quarter of 2013, the
unprecedented combination of ultra-rare futures forced liquidations
and a mass exodus out
of the flagship GLD gold ETF hammered gold down 22.8%.This was the worst
quarter for gold in something like a century, an extraordinarily-anomalous
once-in-a-hundred-year disaster.
Many major gold miners responded to this in the most conservative way possible,
they assumed those quarter-end $1200ish gold prices were the new norm and
aggressively wrote down their gold projects accordingly.These billions and
billions of dollars of non-cash writeoffs have zero impact on
operating profitability, but they will totally overwhelm and wipe out most
accounting profits until they roll off trailing twelve-month earnings.
I happen to be a Certified Public Accountant, I started my career after
college auditing mining companies for an elite Big Six firm.Personally I think
these massive gold-project writeoffs were not reasonable at all.Markets
nearly always mean revert dramatically out of extremes, and indeed after
falling 22.8% in Q2 gold rebounded 7.8% in Q3.Odds are gold will continue
climbing out of that once-in-a-century fear super-storm.
So if I had been advising these gold miners, I�’d have told them to
look at trailing-twelve-month average gold prices before making
write-down decisions.As of the end of Q2 when gold languished just above
$1200, its average price over the past year was still 30% higher at
$1604.Gold�’s year-to-date average today is $1446.So the assumption that
gold would trade at or below $1200 forevermore was very poor.
Thanks to these massive Q2 non-cash writeoffs, many gold miners today show
no accounting profits.And they won�’t for another year.But at the
operating-earnings level, they are still very profitable and spinning off
tons of cash.If the writeoffs bother you, remember that they only happened
after Q2.Even if you ignore all P/E and dividend-yield data after Q2,
gold stocks were still hugely profitable in 2013 before that.
And I mean hugely.For many years now my business partner Scott
Wright has been doing deep research into the underlying profitability of
elite HUI gold miners from another perspective.He�’s constructed an
awesome database of gold-mining costs and margins, which he last wrote about in a May essay.This
incredible chart highlights the massive growth in gold-mining profitability
before 2013�’s stunning anomaly hit.
The blue bars are the average annual gold price, while the red show
average cash costs of HUI component companies.Hold that thought on cash-cost
objections, I�’ll get there.The yellow bars show the gross-margin
percentages for the HUI gold miners, while the yellow numbers show the
average cash profit per ounce of gold mined.This data should shatter any
doubt that gold miners can weather 2013�’s epic fear maelstrom.
Last year, the HUI gold miners that produce over a third of the world�’s
mined gold supply averaged $950 per ounce cash profit!Their gross
margins have hovered in the 50% to 60% range continuously since 2006.There
are very few industries in the world that have such high gross margins, the
profitability of mining gold has been extraordinary.And this provides a
fortress-like buffer to survive this year�’s gold plunge.
Mining costs have indeed been rising, but one thing the bears forever fail
to mention is much of this is by design.The higher the gold price
climbs, the more gold miners can focus on lower-grade ore to increase their
production.When the ratio of gold to waste rock is lower, the price to
extract each ounce naturally climbs.Gold miners chose to pursue
lower-grade projects, which drove much of their rising mining costs.
Over the past four years, average cash costs of the elite HUI gold miners
have grown 13.8% annually on average.So apply a similar increase to 2012�’s
average cash cost of $719, and you get a 2013 projected cash cost of $818 per
ounce on trend.Odds are cash costs will actually come in lower, since
gold miners can modify mining plans in many cases to target higher-grade ore
to compensate for a gold-price downturn.
The average gold price this year is $1446, implying still-massive gross
margins of $628 per ounce at costs rising on trend.This is still much bigger
than all but the last several years of this secular gold-stock bull!If gold
plummets like the bears forecast and averages just $1000 in the fourth
quarter of this year, the full-year average gold price will still be
$1342.Even that hyper-bearish case would leave gross margins of $524 per
ounce!
Of course cash costs are out of vogue today in favor of �“all-in
sustaining costs�”, the full costs of producing gold including
exploration and bringing new mines online.Indeed they are much higher, rumored
to be around $1100 to $1200 globally although no one knows since not all
gold miners report them and the ones that do measure them differently.But
all-in sustaining costs are not very relevant to gold miners weathering 2013.
When times are tough and a major pricing anomaly has to be survived, all
that matters is immediate cashflow.While gold miners have to slow
exploration for new deposits and construction of new mines when gold prices
are weak, the costs of their existing mines are already sunk.As long
as their cash costs are below prevailing gold prices, they can keep
running these mines to pay the bills until gold inevitably recovers.
Consider all-in sustaining costs versus cash costs at an individual-person
level.If someone gets laid off, their income drops, all that matters until
they get another job is cash costs.They have to pay ongoing bills, but they
usually don�’t have to replace their appliances or cars or buy a new
house until their situation normalizes.Gold miners weather adversity just
like individuals do, by delaying major purchases to pay bills.
And there is no doubt gold prices will continue recovering.The extreme
forces that drove the second quarter�’s once-in-a-century gold plunge
were unsustainable and self-limiting, they are already slowing and
reversing.The wild
extremes in both gold-futures long and short positions held by American
traders are mean reverting, and the epic mass exodus out of
the GLD gold ETF driven by the levitating US stock markets has petered out.
Gold investment demand will return even in the United States as the full
magnitude of the Fed�’s massive QE3 inflation campaign gradually
becomes more apparent.Thanks to the Washington budget fight and Obama�’s
appointment of a new uber-dovish Fed chairman, QE3 is going to
continue creating money out of thin air to monetize US Treasuries for many
months to come.Gold will absolutely return to favor again.
Will you be ready?If you listen to the bears and their endless
rationalizations of why it is smart to stay bearish at wildly-anomalous lows
after extreme price declines, you probably think gold and gold stocks are
going to fall forever.That�’s a terrible mistake.All markets are cyclical,
both prices and sentiment ebb and flow.The extreme fear plaguing
precious metals can�’t last, the sentiment pendulum will swing the other
way.
At Zeal we�’re going to multiply our fortunes as gold and gold stocks
mean revert back up to far higher fundamentally-normal levels.We continue to
detail our specific trades in our newsletters, where we own elite gold and
silver producers trading as cheaply as 5x earnings!Many of these great miners
are so oversold and loathed that their prices ought to easily at least
quadruple.Their coming gains are likely to be gigantic.
You can easily partake in the profitable fruits of our contrarian labors,
enjoying our decades of hard-won experience, knowledge, and wisdom for
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a private consultant.Since 2001, all 655 stock trades recommended to our
newsletter subscribers have averaged annualized realized gains of +28.6%!Why
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The bottom line is the dominant bearish gold-stock rationalization today
that gold miners can�’t earn money is totally false.Contrary to the
assertions by shameless perma-bears, the gold miners continue to earn big
operating profits even with 2013�’s anomalously-low gold prices.These
stocks have never been cheaper relative to their underlying earnings (or
gold) in their entire secular bull, they are screaming bargains.
Even at $1200 gold, the ongoing cash spun off from the great majority of
existing gold mines is massive.Though the miners have prudently slowed
non-critical expenses like exploration and mine construction, they can easily
ramp these back up as gold recovers.And it will, with miners emerging from
survival mode leaner and stronger.The deeply-oversold universally-loathed
gold stocks are perfectly set to soar.
Adam Hamilton, CPA
October 18, 2013
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information.
Thoughts, comments, or flames?Fire
away at zelotes@zealllc.com.Due to
my staggering and perpetually increasing e-mail load, I regret that I am not
able to respond to comments personally.I will read all messages though and
really appreciate your feedback!
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