Gold and Gold Miners

By: Ian Campbell | Thu, May 31, 2012
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Why Read: Because almost every day now there is Media and Internet commentary on the current prices at which gold mining stocks are trading:

This commentary includes views you may want to consider carefully if you participate directly or indirectly in the physical gold or gold stocks markets either as investor or trader.


Gold Companies and Gold Companies

Some commentators talk and write about 'gold mining stocks' as if they 'are all the same thing', and all fall into one broad category. That is overly simplistic. It is important when reflecting on 'gold stocks to carefully distinguish between companies that:

Subject to prevailing and prospective financial market conditions, it is arguable that the best of the gold exploration companies represent what can turn out to be very high return investments/trades;


Underlying Financial Market Assumptions and Issues

Commentators talking and writing about 'gold mining stocks' often seem to base their views on unstated underlying assumptions that:

Commentators also frequently seem to base their views with respect to 'gold stocks' to a greater degree than perhaps they should on historic financial market experience - this having regard to the:

For the foregoing and other reasons the current financial markets arguably are quite different in many important respects from the pre-2000 financial markets, and to some degree different from the pre-2008 financial markets.

Finally, some commentators in the current financial markets environment also seem to have forgotten, or now discount, what happened in the fall of 2008 when many investors and traders had to sell out positions based on margin calls and 'flight to investment/trading safety' reasons.

It is important to always remember that rising tides raise all boats, and falling tides drop them, often leaving some 'high and dry'. Gold exploration, development, and mining stocks are unlikely to be exceptions to that rule.


Consider carefully whether the Financial Markets 'May Be Right' in their Current Gold Mining Share Pricing

With that background, consider that gold mining company share prices (read 'shares of companies that actually produce gold) are not simply 'derivatives' of gold (as suggested by at least one commentator), nor are 'gold's fortune's' the 'only real long-term fundamental' of gold stocks (as recently suggested by a second commentator). That said, it is correct to say that at any given point in time the prices of gold mining stocks (and gold exploration and gold development company stocks) are influenced by the then gold price and then expected gold 'trend price'. In turn, it currently seems that the price of physical gold is being continuously influenced by a financial markets perception that the U.S.$ is itself a safe haven in turbulent economic times.

Following from the foregoing, the financial market 'disconnect' perceived by some may well simply be that the current prices of gold mining (producing) stocks are, aside from the physical gold price, result from strongly being influenced by important risk and operating cost issues, including:

Finally, gold producer stock prices may also currently be influenced (downward from what they otherwise might be) by the proliferation of ETF's and other paper gold instruments. Simply put, investors and traders currently have physical gold investment/trading alternatives that didn't proliferate until after late 2004. These alternate gold investments/safe haven holdings eliminate country risk and operating cost/environmental cost risks in the context of investor/speculator/trader buy/hold decisions.

It follows (or ought to follow) that for gold mining (producing) companies to be attractive going forward they will need to be able to demonstrate at least the following things:

Thereby to some degree offsetting the business and operating risks implied by the foregoing.


So What Does All This Mean?

As a result of the foregoing, it can be argued that:

Moreover, these things may, in combination with what appears to be ever more worrisome world macro-economic issues, result in;

That said, make no mistake, generalizations with respect to gold companies and their share prices - be they explorers, explorer/developers, or miners - are very dangerous, and broadly should be viewed with skepticism. Gold companies at all levels are participants in a highly speculative, high risk industry where their revenues are driven by world prices they themselves do not control. They can, of course, hedge to protect their revenues if they elect to do that - but based on existing accounting rules, hedging itself can be harmful to earnings per share in a 'rising gold price' environment.


Conclusions

In conclusion:

We live in complex and difficult macro-economic times. Ultimately, whatever happens in the world and in country specific economies will influence the financial markets. A simple message: 'Do not be taken in by generalities, or by opinions that fail to provide the underlying significant assumptions (and logical support for those assumptions) that back up those opinions'. There is a lot of unsupported opinion to be found on the Internet and elsewhere.

Going forward, specific gold exploration companies, gold exploration and development companies, and gold mining companies may prove to provide excellent risk/reward investments or trades. That said, tread carefully, listen to and read much, be highly skeptical and cynical, and 'think for yourself' at all times - but particularly in the current economic and financial markets environment - before 'jumping off the diving board into the pool'.

 


 

Ian Campbell

Author: Ian Campbell

Ian R. Campbell, FCA, FCBV
Economic Straight Talk

Through the Economic Straight Talk Newsletter Ian R. Campbell shares his perspective on the world economy, the financial markets, and natural resources. A recognized business valuation authority, he founded Toronto based Campbell Valuation Partners (1976), Stock Research Portal (2007) a source of resource companies market data and analytic tools, and Economic Straight Talk (2012). The CICBV* annually funds business valuation research in his name**. Contact him at icampbell@srddi.com.
* Canadian Institute of Chartered Business Valuators
** through The Ian R. Campbell Research Initiative

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