The Performance Of Gold Mining Stocks

Gold mining stocks have spent the past year going nowhere in what is essentially a wide trading range that looks like a complex corrective formation. What is so surprising is that this has coincided with a big rally in gold and a shift in silver prices to a much higher trading range. To this it should be noted that many of the mid tier gold miners produce significant amounts of silver as a byproduct, while both the major gold stock indexes (HUI and XAU) contain a few component stocks of primary silver producers.

There are several reasons why the stocks of gold miners have failed to reflect higher metal prices. There two fundamental reasons: one is the fact that their input costs have risen in tandem with the gold price. Everything from labor to energy (the two most important input cost factors) to steel and chemicals has become far more expensive.  The other is that the big gold mining firms have acquired a reputation for being less than astute in their employment of capital. In order to 'buy growth' or merely to replenish mined out reserves, they often engage in expensive acquisitions that in many cases require significant additional capital investment before they produce a profit. Since not only mining costs but also mine development costs have been rising sharply, this has led to a combination of shareholder dilution and a lack of dividend growth. Both of these fundamental factors are changing now (see further below).

Another reason is psychological. The bull market in gold and silver has been disbelieved by the majority of market participants all the way up. We are not referring to the CTA's (commodity trading advisors) and hedge funds here that are the major speculative traders in gold futures. These two groups can be considered trend followers – as a rule, they don't try to second-guess strong trends.

However, in the mainstream investment world, gold has yet to find acceptance. It is the asset people 'love to hate' for some reason  – presumably the fact that it 'pays no dividend' and is not amenable to the same type of supply-demand analysis as industrial commodities both play a role in this refusal to consider its investment merits. We suspect that the fact that gold challenges the modern-day economic orthodoxy is also a reason for the hostility some people harbor against it.

This orthodoxy of course holds that we need a centrally planned 'flexible' fiat money to ensure smooth economic development – and it is probably one of the costliest economic errors since the Bolsheviks established socialism. Gold's bull market is a constant and embarrassing reminder that the markets are losing their faith in the monetary bureaucracy.

Ironically, it is this very disbelief that has helped to keep the bull market alive – since it has ensured that many investors remain on the sidelines, representing a large reservoir of future demand. After all, gold is in a bull market that is based on sound fundamental reasons – so bit by bit, former doubters are turned into believers. And yet, the expectation that the bull market will soon end has inter alia weighed on gold stocks over the past few years. The perceived risk of buying stocks at the peak of the cycle is very likely a major consideration that has kept investors away.



The HUI Index of unhedged gold stocks has been going sideways in a corrective formation in spite of the big rallies in gold and silver – click for higher resolution.


The HUI-gold ratio shows that the gold stocks have weakened against gold since early April – click for higher resolution.



However, the earnings reported by gold mining firms last quarter not only showed that costs were still rising, they also gave a strong indication that these firms nonetheless enjoy a lot of earnings leverage to the gold price. Even companies that failed to exceed 'Street expectations' (this 'expectations game' is complete nonsense anyway, but even more so in the case of mining companies) showed large year-on-year increases in free cash flows and earnings. Meanwhile, gold in the ground in the form of reserves and resources has obviously become far more valuable as well. As the gold price rises, lower grade ores that were not economically viable before have become so, and gold mining firms are economizing by mining some of these ores in order to lengthen the life of their mines.

Moreover, it appears that the managements of gold mining companies have finally decided it is time to listen to the pleas of investors to raise their dividends. We haven't kept precise tabs on it, but a great many producers have in fact raised their dividends lately, with several pledging to continue to do so.

Given that the gold price was quite a bit lower last quarter than it is at present,  reasonably strong earnings seem set to continue even in the event of a gold price correction.

Lastly, the most important factor in gold mining profitability is of course the difference between mining input costs and the gold price, not the level of the gold price as such. Gold has a peculiar characteristic: in times of growing economic uncertainty and during recessions, its price tends to rise against the prices of all other goods. This is due to gold being the only form of money the supply of which can not be increased at will. Since the demand for money tends to increase in times of declining economic confidence, the gold price will tend to rise against other goods in such time periods. As a consequence, gold mining stocks are the only market sector that exhibits a long term inverse correlation with the broader stock market. In the short term, this is often obscured by factors such as declining market liquidity, but in the long term it is undoubtedly the case. For example, the S&P 500 was at roughly 1,500 points in the year 2000 when the gold bull market began, while the HUI index hit a low of 35 points in the same year. Today the SPX trades at 1180 points, while the HUI trades at 564 points (a decline of approximately 21% versus an increase of over 1,500%).

In short, during secular contractions, gold and gold mining stocks are a much better investment than the broad stock market. Given that secular contractions  historically last between 16 to 25 years, this is likely to remain the case for a good while yet.

Recently economic data have once again deteriorated globally – not surprisingly, gold has therefore begun to rise strongly against everything else. Gold mining firms have just experienced a big boost to their profit margins  and eventually this should be reflected in their share prices.


Gold's Relative Price

Gold has been rising strongly against all fiat currencies, as well as commodities,  stocks and bonds of late. In spite of the strength in t-bonds and many non-dollar currencies, gold has still managed to outdistance all of them. The rise of gold against commodities is what is most relevant to gold mining margins, especially gold's rise relative to energy prices. Below are a number of charts illustrating these developments. Long time readers may recall that we wrote about a similar phenomenon before – back in the depths of the 2008 financial crisis. Even though gold's nominal price (i.e., its dollar price) fell at the time due to a strong rally in the US dollar as a global scramble for dollar liquidity took hold, its price still rose strongly against commodities, boosting the profit margins of gold miners. It is interesting to note in this context that this was one of the occasions where the market was simply 'wrong', or rather, an occasion where technical factors (the need to become liquid coupled with averse market psychology) temporarily overrode fundamental factors (rising profit margins), creating a rare buying opportunity in the sector. So much for the 'efficient market hypothesis' – the knowledge that profit margins in the sector were rising was not enough to keep the gold stocks from trading at a vast discount and ironically the discount only narrowed again when these favorable conditions actually became less favorable in the subsequent commodity price rebound.



Gold relative to the CCI (continuous commodity index, the equal-weighted version of the CRB) – in a strong uptrend since February – click for higher resolution.



Gold vs. the CRB Index – it has been even stronger vs. this commodity index that contains a heavy energy weighting – click for higher resolution.



Gold relative to crude oil – this is incidentally the highest level in this ratio since early 2009, around the time the stock market produced its crash low. As energy is one of the most important input costs in gold mining,  a high gold-crude oil ratio is a great boon for the industry's profit margins – click for higher resolution.



Gold vs. platinum – platinum is a precious metal as well, but one the supply-demand characteristics of which are far more akin to that of an industrial commodity, whereas the bulk of gold demand is largely monetary, or investment demand. It is therefore logical that gold's price will rise against that of platinum when economic confidence declines. Note by the way that we think platinum's fundamentals are bullish as well, even though it is currently hampered by perceptions about the economy – click for higher resolution.



The gold-silver ratio shows that gold has also been rising against silver lately, a warning sign for the economy akin to widening credit spreads (in fact, credit spreads have been widening concurrently). Alas, silver is the 'hybrid' among precious metals – it is regarded as both an industrial and a monetary commodity and over the past year the latter characteristic seems to have grown in importance – click for higher resolution.



Gold vs. the 10 year treasury note over the past two years. Treasuries may still be in a bull market in dollar terms, but they are in a bear market against gold – click for higher resolution.



Lastly, in terms of profit margins, gold mines situated in countries with strong currencies have struggled to profit from the bull market. This is no longer the case, as gold's price  has lately broken out to new high ground even against the strongest so-called 'commodity currencies'. In fact, as far as we are aware, the only currency in the world against which gold has not yet reached a new high is the Swiss franc, but even against this strongest of all fiat monies it has recently strengthened and has maintained a bullish-looking chart.



Gold in terms of the Australian dollar. Gold mining margins down under are rising strongly as well now – click for higher resolution.



Gold in Canadian dollar terms – this is new high ground as well – click for higher resolution.



Gold in terms of the South African Rand.  South African producers are the most marginal (highest cost) producers in the world. The move in the Rand gold price should provide an especially strong boost to their profit margins – click for higher resolution.



The Swiss franc has been the only viable competition for gold in the currency arena (ironically, just like gold, it has no yield). Even so, the chart of gold in CHF looks favorable to gold – click for higher resolution.


The other 'safe haven currency', the Japanese yen. Gold remains in a strong bull market in yen terms as well – click for higher resolution.



Gold in terms of the misnamed pound sterling – the uptrend has accelerated – click for higher resolution.



In euro terms gold has been very strong as well – we previously remarked on the bullish gap up over the old high. This is a case where a gap has turned into support – click for higher resolution.



Finally, below is the ratio of gold to the Dow Jones Steel Index and Lumber. Note that the ratio to the steel index is an imperfect way of looking at things, as the index consists of steel stocks, but as this paper (pdf) shows, the share prices of steel stocks are actually a fairly good leading indicator of steel prices. Also, the charts of various steel prices themselves (see world steel prices) show that while steel prices have been rising, they are still quite a bit below their 2007/8 highs, i.e., gold has been rising more strongly. Steel and lumber are both important input cost items in mining.



Gold vs. the Dow Jones US Steel Index – click for higher resolution.



Gold vs. lumber – this is a new high as well – click for higher resolution.



Lastly, here is gold in dollar terms – the recent advance has been near 'parabolic' and a correction seems likely, but even if prices come back a little, the profit margins of gold miners should remain strong – click for higher resolution.




The stock prices of gold mining stocks do not yet reflect the increase in gold mining margins – not even the margin increase that has already occurred as per recently reported earnings, not to mention the additional margin increase provided by gold's recent rise against commodities. It is unknowable when the market will reassess the situation, but it seems highly likely that it will be reassessed at some point.

Note here that in the latter half of the 1970's gold bull market, it also took a while before gold stocks finally reflected the higher profit margins provided by the rise in the gold price (holders of gold stocks had to go through a frustrating period of underperformance from mid 1976 to roughly mid 1978, while the gold price rose strongly). In fact, gold stocks rose to a higher high relative to gold in the second half of 1980 after the bull market had ended. This 'double non-confirmation' (first gold made a higher high in January of 1980 concurrent with a lower high in gold stocks, followed by the exact opposite in September 1980)  was in fact one of the signals that indicated that the bull market had come to an end. There is no way of knowing how exactly things will play out this time, but it is always a good idea to keep in mind what has happened in the past. Meanwhile, the Fed's recent promise to keep its short term interest rate at zero for a minimum of two years is quite bullish for gold itself.

Should gold stocks eventually break out from the trading range that has pertained over the past 10 months, a strong move can be expected.



We recently wondered whether Al-Quaeda's leader Ayman Al-Zawahiri would live to see the decline of Western civilization. We can now happily report that we have been spared this fate by the ultimate contrary indicator – a Time magazine cover. However,  the  'maybe' in the title below worries us a little (according to Time, Europe is done for, and 'maybe' the entire West). Anyway, there is a good reason why the so-called 'magazine cover indicator' works so well (and we would note, per experience  it works especially well with 'Time').  By the time general interest magazines report on a trend, the trend is usually at an extreme and ready to reverse. One possible hopeful conclusion from Time's most recent cover is that the trend  toward more statism and interventionism is going to be thoroughly discredited and will come to an end in Europe, since that is the only way the magazine cover indicator can work its contrary indicator magic once again in this case.



Time says Europe is finished – the strongest sign yet  that it probably isn't. A famous recent 'contrary indicator' cover by Time magazine was the one celebrating the US housing bubble in 2006. It marked to peak to within days or weeks.




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15 Responses to “Gold and Gold Mining Stocks, An Update”

  • after:

    Any thoughts on HMY right now ? Please and thank you.

    • Hi, I’m personally inclined to stay the course. HMY reported a pretty weak quarter, but one must consider here that this was the quarter during which it negotiated with the NUM, so it would have been impolitic to report a very strong quarter. Once you look closely at the mine-by-mine performance, you realize it wasn’t as bad as they made it out to be.
      Besides that though, to me HMY is all about the PNG (Wafu-Golpu)discovery now. The value of this discovery is simply not reflected in the stock’s price, and I continue to believe that HMY has become a very likely takeover target. Note that the gold-equivalent ounces of Wafi Golpu have risen by 30 million ounces to 70 million ounces quarter-on-quarter. I would advise patience.

  • Floyd:

    What would be a sound allocation to the PM sector (as percentage of assets)?
    What portion in metals vs. miners?

    • One can not really answer that question, as this must really be considered on a case by case basis. If you have ZERO exposure, you should certainly use pullbacks to get some. If you do have exposure, consider that in current times, an overweighting may make sense and once again, pullbacks should be used to put it in place. However, the details all depend on your risk tolerance, your financial goals, your age, etc. – the fact remains though, this is the only market sector that is in a genuine bull market at present.

  • Jay:

    I was an investor in junior gold & silver mining stocks in the early 80s. I saw most of those stocks go to zero before the end of the decade. One of the silver miners that didn’t go to zero, during all those years when nobody wanted silver, recently went to zero once silver prices really started taking off. This is why it’s so much better to own the metal rather than the miners of the metal: the metal won’t go to zero.

    • Certainly one can not buy the stocks blindly – a great amount of due diligence needs to expended if one wants to select specific stocks to invest in. These days, the ETFs give you a viable alternative though (such as GDX or GDXJ).

  • amun1:

    There is one other possibility for the underperformance of the miners relative to the metal, and that’s fear of confiscation. At 1750 an ounce, gold is pricing in more than just a bout of inflation; it’s rightfully forecasting the risk of real turmoil in the fiat currency paradigm.

    If the market is right, then hard money could come back into vogue with a violent spike in demand that makes everything to date pale in comparison. If that happens, governments won’t be buyers, they’ll be takers and confiscating gold in the ground is a lot easier than going house to house.

    So there may be no upside to buying miners at these gold prices. Either economies grow fast enough to pay down debt and fiat money stabilizes, or gold mining stocks price in an ever increasing risk of having their future ouput nationalized. It’s just a hypothesis, but worth considering.

  • eo:

    Who were the sellers of pm stocks in ’08?

    • 2008 was a big deleveraging orgy. Most hedge funds were hit with both margin and redemption calls and simply HAD to sell whatever they could. It did not matter what the fundamental situation was, it was all about getting liquid. That obviously changed again once the deleveraging period was over.

  • contulmmiv:

    Correction: the first line, between quotation marks:
    “So much for the ‘efficient market hypothesis’ ”


    • Yes, as I already pointed out, I use the term exclusively in connection with the theory that asserts that it is impossible to win at the investing game by outwitting the market because the market prices of stocks allegedly at all times already reflect the ‘wisdom of the herd’ and are pricing all available information in – the herd is however often better opposed than followed in the stock market.

  • contulmmiv:


    I didn’t know whether to laugh or to cry. Then, I decided I _must_ go for the laughter: I cried too much over the pointlessness of any discussion and the incapacity of even the best of people to discard prejudice once it got solidly knocked into their heads. Sociobiology: infatuation with personal “grandeur”, vanity of authority over the “flock of followers”, reception of any criticism as a threat to “leadership” – these are universals overpowering all else…

    As to the miners, one can find here a sensible explanation of their underperformance. While here one can find an illuminating clarification of the confusion between performance and leverage that many a gold miners aficionados make. “One” meaning one interested to revise his/her views, that is…

    Best regards, Patenebr.


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