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Gold and silver mining stocks have sold
off by roughly 30% from their 52-week highs based on the PHLX Gold/Silver
Sector Index (XAU) and by roughly 32% based on the Amex Gold Bugs Index
(HUI). In comparison, gold is down approximately 14% from its nominal all time high in 2011 while silver is down approximately
37%.
The XAU / Gold ratio suggests that gold
and silver miners are oversold. In fact, the shares of some companies are
trading below their net asset values.
Metal Price Trends
Despite having come down from their 2011
highs, gold and silver prices have shown stubborn resistance below $1650 for
gold and below $30 for silver. When prices have broken through these levels,
the metals have rebounded. Unlike the breakdown in gold and silver prices
after the 1980 mania, gold and silver prices are currently stabilizing at
lower levels.
Although prices remain volatile from day
to day, current prices appear to reflect a trading range that suggests a
consolidation.
Adjusting the Price of Gold
Adjusted using the current U.S. Bureau
of Labor Statistics (BLS) Consumer Price Index (CPI), the 2011 highs in gold
and silver prices appear similar to the bubble of 1980, but the BLS has
changed the way that the CPI is calculated since 1980.
Based on the 1980 formulation of the
CPI, which is still calculated by economist John Williams of Shadow
Government Statistics, gold and silver prices do not appear to have been in a
bubble in 2011.
In addition to changes in the
calculation of CPI since 1980, the Federal Reserve’s funds rate is
currently close to 0% rather than the 1980 average of 13.36% and the Federal
Reserve cannot realistically raise rates in the face of weak economic
fundamentals, overleveraged banks and excessive debt levels. Unlike the
1980s, the world reserve currency status of the U.S. dollar is slowly
deteriorating and the future of the Euro, which was introduced in 1999, is
unclear.
Prices Measured in What?
Artificially low interest rates,
government deficit spending and quantitative easing by central banks, e.g.,
the Federal Reserve’s central bank liquidity swap lines and the
European Central Bank’s (ECB) Long Term Refinancing Operation (LTRO),
expand the money supply independent of sustainable economic activity and
population growth. When the money supply expands in a disproportionate way,
the value of money falls and prices rise as a result, i.e., because of
currency debasement.
Currency debasement will continue in the
foreseeable future. Current monetary and fiscal policies in the U.S., the
United Kingdom, the European Union and Japan, prevent large, overleveraged
banks from failing and allow high levels of government borrowing to continue
despite higher debt levels and lower tax revenues resulting from weak or
deteriorating economic fundamentals.
Given the economic and financial
condition of Western countries, as well as Japan, it is not practicable for
monetary expansion to abruptly cease or for money supplies to be quickly
brought back in line with sustainable economic activity and population
growth. In other words, there is no practical way for central banks to stop
currency debasement without bank failures and sovereign defaults.
Value Versus Psychology
With gold and silver prices at or above
current levels, some gold and silver mining stocks are severely undervalued.
However, exploration companies without substantial defined resources and
producers that have relatively high production costs or relatively low grade
deposits are less likely to rebound when mining stocks begin to recover.
Metals prices stuck in a trading range
and higher oil prices, thus, higher energy costs, are crushing the prices of
exploration stocks and impairing the share prices of producers with higher
production costs or lower grade deposits. In contrast, the share prices of
gold and silver mining companies achieving consistent growth in resources and
reserves, production, revenues and cash margins can be expected to rebound
vigorously when confidence in metals prices firms. Cash flow will separate
the wheat from the chaff.
The question on the minds of many
investors is “Where is the bottom?” Many fund managers have
pulled out of gold stocks after making little progress in the past year or
more, and there is a growing sense of despair in the marketplace. At the same
time, investors who pulled out are afraid to get back in. What is important
about the pervasive negative sentiment is that it is a key indicator of a
market bottom. At the top of the market, there are a hundred reasons to buy
and, at the bottom of the market, there are a hundred reasons to sell. If
psychology is any guide, gold stocks have hit bottom.
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