Why Are We Certain that Gold Producers Will Soar?
For the past eighteen months, gold stocks have been pummeled.
They showed some life from mid-May to mid-June - GDX, the gold miner's index, was up 21%, while gold rose 5.5%. That bounce was exciting, but they've still got a lot of lost ground to make up. Since January 1, 2011, GDX is down 28%, while gold is up 10%.
So what's going to move these darn stocks? Will their day ever come? Could our research - gulp - be wrong? Jokes have even started circulating.
- What's the difference between a seagull and a gold stock investor? The seagull can still make a deposit on a Mercedes.
- Gold equities may be bad, but I slept like a baby last night. I woke up every hour and cried.
Laugh or cry, underneath this heap of stock-certificate debris is the contrarian opportunity of a lifetime.
That's a strong statement, I know, but there are numerous well-researched reasons why I'm convinced gold stocks are one spark away from igniting the portfolios of those with the cash to buy, courage to act, and patience to hold. And it's not just because they're undervalued, something that's been the case for at least eight months.
Let's review the core reasons why gold stocks are the place to invest right now, and why I'm convinced much higher prices will be had before this bull market is over.
Reason #1: Gold stocks have leverage to gold bullion prices. In spite of what's occurred recently, history is on our side here, as the track record of precious metals equities demonstrates they can reward patient investors tremendously. They rose:
- 950% from January 2001 to January 2008.
- 700+% from 1970 to January 1980, including 289.5% in the last thirteen months of that period.
- 211% in less than 24 months in the mid 1990s.
- Even during the Great Depression, the two largest producers at the time - Homestake Mining and Dome Mines - rose 474% and 558% respectively.
It's normal for gold stocks to demonstrate this kind of leverage to gold. It would completely contradict the historical pattern - and common sense - for gold stocks remain where they are until this bull market ends.
(And sometimes, even when the price of gold bullion falls, gold stocks can still offer big upside. Case in point: in the 24 months from January 1, 1981 to January 1, 1983, while the price of gold bullion fell by 25% - from $597 to $446 - gold stocks rose 72%. A series of giant gold discoveries in Canada set off a mini-mania in the equities.)
Check out the historical record, which includes some mind-boggling performances by juniors.
Reason #2: Gold stocks are grossly undervalued. Gold stocks aren't just inexpensive, they're stupid cheap. Their current undervaluation is more than just compelling. it's fire-sale attractive. It should have your full attention.
Just look at the data and you'll see what I mean:
- Relative to gold, the equities have not been this cheap since the waterfall selloff in 2008. The HUI/gold ratio is roughly 0.27, close to its bottom of 0.24 in October 2008. It hovered between 0.50 and 0.60 for most of a five-year period from 2003 to 2007, and exceeded 0.60 several times.
- On average, and in spite of weak gold prices at present, industrywide margins are roughly $1,000 per ounce. The price of gold wasn't even $1,000 30 months ago.
- As a group, gold stocks are selling for less than their net asset value. by 20%. They traded 60% above their NAV in 2007, a common level for precious metals equities.
- Average P/E ratios of the 10 largest gold producers are less than half what they were just two years ago.
- As we mentioned a few weeks ago, for a $1,000 investment right now, you can get about 0.6 ounces of gold. For the same $1,000, however, you'd get four ounces of gold by buying shares of Goldcorp or more than five ounces by buying Eldorado Gold.
This undervaluation cannot and will not last. Even the trader who knows nothing about Newmont or Barrick or Goldcorp will sooner or later want to jump on this - and if he doesn't, his boss will want to know why. Read what one Sprott fund manager thinks about gold stocks.
Reason #3: Gold stocks are universally under-owned. There are plenty of reports about how little gold and silver the average mainstream investor owns - which likely means they own even less of gold equities. But the disconnect is bigger than you realize.
In the institutional world, pension funds sit at the head of the table. However, the typical fund devotes only 3% to commodities, and of that 3%, only 5% is committed to gold and gold stocks. In other words, only 0.15% of assets are in gold and another 0.15% in gold mining stocks, a pathetic total of less than one-third of one percent. Ditto other institutional investors.
Given the gamut of sovereign risks in virtually the entire world, even the developed world, the lack of gold and gold stock ownership is appalling. That will change as the growing fiat currency risks around the world impact investors more deeply.
Reason #4: All that cash has gotta go somewhere. It's one thing to say gold stocks are under-owned, but is the money available to buy them? One could make an argument that any rush into gold equities would be muted if no one has any savings or if demographics dictate that a fifth of the developed world will soon be retired.
At the end of Q1, S&P 500 corporations had $1.7 trillion in cash and another $4 trillion in short-term investments. The M1 money supply is currently $2.2 trillion. Pension assets exceed $31 trillion, more than twice the size of last year's GDP in the US.
Contrast those figures with the market cap of all primary gold producers trading in North America: about $800 billion. Or the market cap of all primary silver producers: a measly $32 billion.
- If corporations moved 5% of their "short-term investments" into gold stocks, the market cap of the industry would increase by 20%.
- If they chose silver stocks, it'd grow by a factor of six.
- Five percent of M1 would increase the market cap of gold producers by 14%; it would be 3.4 times bigger than the entire current value of all primary silver producers.
- If pension funds doubled their allocation to gold stocks (making it a puny 0.6% of total assets), it would amount to $93 billion in new purchases. If they went to 5%, $1.5 trillion would flood the industry.
Check out the chart of these data. And by the way, don't forget other corporations in the US and around the world, insurance companies, hedge funds, sovereign wealth funds, mutual funds, private equity funds, private wealth funds, ETFs, and millions of global retail investors. There are, quite literally, tons of cash available for investment in whatever sector the mainstream targets.
What if they all enter the gold market at or near the same time?
Reason #5: Physical gold may become hard to get. The gap between supply and demand isn't letting up. Since 2001, worldwide production is flat, despite a sixfold increase in the gold price - and demand has grown from $3 billion to $80 billion.
I'm in touch with bullion dealers on a regular basis, and they're all saying the same things. Andy Schectman of Miles Franklin insisted that the bullion market "will ultimately be defined by complete lack of available supply." Border Gold's Michael Levy cautioned, "If an overwhelming loss of confidence in the US unfolds, the demand for physical gold and silver will far outweigh all known inventories." And Mike Maloney of GoldSilver.com warned that if shortages develop, "physical bullion coins and bars might become unobtainable regardless of price."
As increasing numbers of people view gold as a must-own asset, and as supply is not keeping up with demand, where is the next logical place for investors to turn to get exposure? Gold stocks.
Imagine the plight of the mainstream investor who calls a bullion dealer and is told they have no inventory and don't know when they'll get any. Picture those with wealth finally becoming convinced they must own precious metals and being informed they'll have to put their name on a waiting list. Imagine a pension fund or other institutional investor scrambling to get more metal for its fund and being advised the amount it wants is "currently unavailable."
Mining equities would be the fastest way to meet that demand. It'll be the next logical step to take - maybe the only sensible step available if the supply of physical metal remains constrained. It will feel like the most natural thing in the world for them to do. It is indeed the overlooked reason gold stocks will soar.
Reason #6: Gold has a lot further to climb. This is why I'm convinced gold stocks will soar again: a rising gold price. Many investors have focused on gold's lackluster movement for the past eight months, forgetting that it rose a total of 2,333% in the 1970s - with much less currency dilution than we have today. For gold to match the same percentage rise from its 2001 low, the price would hit $6,227 per ounce. Nothing says it has to match that price - but neither does it have to stop there. Given the ongoing caustic actions of politicians, we see much more upside risk in gold than downside.
And here's the key for gold stocks: once the gold price resumes its uptrend and begins making new records again, all sorts of investors - from large market-moving institutions to small retail buyers - will return to gold equities. I suggest beating them to it.
Reason #7: "The boat" has a leak. The dilution of our currency is on a nonstop - and scary - trajectory. Just since January 1, 2000, US dollars have lost a whopping 26% in purchasing power. The Canadian dollar has lost 23%. This is a serious and gross devaluation of what we use for money. Meanwhile, gold has gained 325% in purchasing power (after accounting for inflation as measured by the CPI, which understates the amount of inflation by a considerable amount). And this is while the gold price has gone nowhere since last September.
The problem is, the leak in our economy is only going to get bigger. The monetary base now exceeds $2.6 trillion, up 215% since January 2008; the national debt is over $15.7 trillion and will conservatively reach $20 trillion in just three years; the $1.3-trillion US budget deficit, which is more than the entire US budget was just 20 years ago; the approximate $4 trillion in US Treasuries held in foreign central banks, many of which continue making arrangements to bypass the dollar; the vulnerable and propped-up economies around the globe; the still-unresolved European debt crisis; the many negative real interest rates that show no sign of reversing course anytime soon.
These are massive megatrends that won't be reconciled without further, serious dilution of the currency - it's the only politically acceptable way to decrease the debt burden. This is why we're convinced more money-printing in the US and around the world is highly likely - whether they call it "quantitative easing" or try to hide it under some other guise - especially if we get another deflationary scare. With the only logical choice being to print, gold will be forced higher by an order of magnitude.
I say all this about gold because I think that is the key to gold stocks. If gold and silver are destined for higher levels, gold stocks will follow. I know they haven't demonstrated that for a while now, but slumps don't last forever.
The bottom line is this: Gold stocks do respond when gold goes higher - and gold is going higher because of completely unsustainable fiscal and monetary actions of governments all around the world.
So, will gold stocks really soar again someday? The historical record of gold stock manias. the extreme undervaluation of gold equities. the lack of mainstream participation in our market. the abundance of available cash. dwindling supply and rising demand. the massive disconnect between gold and gold stocks. the likely trajectory of the gold price. and last but not least, the political compulsion to dilute the currency further. all these factors point to an incredible opportunity to buy gold stocks at extremely low levels and someday realize potentially life-changing rewards.
Hang in there, my friends. Our time will come. In fact, I predict that someday we'll wonder why anyone doubted it in the first place.
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