Conventional
wisdom -- backed up by years of observation -- states that gold mining shares
tend to outperform the underlying metal in good times because they're
"leveraged to the price of gold." That is, their extraction costs
are more-or-less fixed, so when gold rises, most of the increase flows
directly a miner's bottom line, increasing its earnings at a rate that
exceeds the metal's move.
With gold
near a record, most miners should put up ridiculous earnings in the year
ahead, which should make their shares act like tech circa 1998, right?
Nope. The
biggest miners, whose shares populate the GDX gold miner ETF, did outperform
gold (represented here by the GLD ETF) during most of its recent epic run,
just as you'd expect. But in April the two trends diverged, and lately the divergence
has become a chasm. Gold is up 22% in the past 12 months and the big miners
are, as a group, virtually unchanged.
This is
painful and humbling for investors who bet on gold by loading up on mining
shares, only to discover that they were right on the macro but wrong on the
implementation. But one person's pain is another's opportunity, and the
market appears to be offering a whopper here.
Assuming that
the long-term relationship between gold and the miners holds -- and there's
no reason to think it won't -- then the trend lines will converge at some
point in the coming year. This can happen in several ways: They can both
fall, but gold more than mining shares. They can both rise, but mining shares
can rise more. Or gold can tread water while the miners
go up.
Which means
there are two ways to play it: Buy the miners and ride them, which will work
if gold goes up. Or short gold and buy the miners, in which case you don't
care where gold goes as long as the miner/metal relationship reverts to
normal. The first is simpler but only works in a rising gold price scenario.
The second is an arbitrage that should work no matter what gold does in the
year ahead, though it carries an emotional price, since shorting gold is
disturbing on a lot of levels.
On the other
hand the idea of making money while being short gold -- in the middle of a
global currency meltdown -- has a certain contrarian appeal.
One final
thought: If the big miners are underperforming because of fears that they
can't replace the reserves they're consuming, then we're in for a buyout
binge as they use their rising cash flow to gobble up the juniors with the
most accessible reserves. So the small-cap miners will end up being the best
part of this market.
John Rubino
DollarCollapse.com
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