On the trials and tribulations of owning gold stocks
About a month ago I wrote the following in an email to a friend:
I probably seem crazy to be chasing gold stocks in and out like I have. I’ve been wrong over and over. But I’m not losing much money doing it because I keep selling before it gets out of hand and I know from experience that when they move up they will move so fast and you have to be ready for it. What we saw in January was nothing, in the past I have had stocks triple in a month when they move. They can move so fast in such a short time its crazy.
At the time I was getting mucho frustrated and more than a little despondent about the reaction of the gold shares. Gold stocks were being sold indiscriminantly. Even though the price of gold was holding up rather well, the stocks of the companies that produced gold were being trashed. For those companies that only explore for gold, the thrashing was even worse.
I follow a few rules for investing. One of those rules is to never add to a losing position. Another rule is to scale out of stocks that are not doing what I think they should do. A third is to mind the intraday reversals. The consequence of following these rules with the gold stocks is that I have bought in and been bounced out of these companies a few times over the last couple of months. I have owned Aurizon Mines, Lydian International, Golden Minerals, Barrick Gold, Newmont Mining. I now own OceanaGold and Agnico Eagle in addition to a large position in Atna Resources and Gold Standard Ventures and (sigh) Canaco that I have held throughout.
While my furstration has left me tempted to walk away from gold completely, the reasons I didn’t give up was three-fold.
First, I just can’t get past the conclusion that the underlying condition of the world right now should be favourable to owning gold and gold stocks. World economies are weak and weakening, and along with it so are the inputs to gold mining. Interest rates are near zero, which means that alternative paper investments (bonds) do not have their usual yield advantage over gold. Central bankers have shown a bias towards printing money to avoid lengthy recessions and prevent a destabilizing banking crisis. Debt in the developed world is still high historically.
In this environment the perception of gold should be favorable, and its perceived value in units of paper currency should increase. The truth is that the price of gold is based on perception. I think that is why you have such wild fluctuations in both gold and gold stocks. Its because gold has no value apart from the value that man has historically perceived in it. And its difficult to nail that down. I am starting to get tired of the term, but to say that gold is the existential commodity is really not very far off.
Second, the gold stocks are cheap. They are trading at multiples that I didn’t think gold stocks would ever see. Newmont and Barrick have been down as low as 8x earnings.
As well, with economies slowing, I think we are finally going to see the benefit to gold mining from lower energy, labour and capital costs. It has become so common for a gold company to report escalating operating costs, or increase the estimate of capital costs to build a new mine, that it is now almost expected by the market. But these costs do not rise in a vacuum. They rise because energy, copper, steel and labor prices have been rising. As economies around the world slow, this effect is reversing. We should begin to see that effect in the second quarter numbers, where cash costs beging to show decline.
The third reason that I didn’t give up on gold stocks is because I know that when they turn, they turn hard. I have been on the outside looking in before when this turned happened. I have learned that it is extremely difficult to buy a stock when it has risen a significant amount in a short period of time. In the same manner that gold stocks have fallen day after day for months, with seemingly no support, they can also do the opposite, and rise very quickly and dramatically in a short period of time. The only way I have found to take advantage of this, given my own constitution, is to be in before the rise begins
In my update last weekend I noted that I had bought a position in OceanaGold and in Newmont. This week I added to OceanaGold and initiated a new position in Agnico Eagle:
I finally had timing on my side with these purchases. Yesterday gold and gold stocks took off after the dismal employment report. I was pleased that in my review of the carnage after the market closed, that because of the outperformance of the gold stocks, I was actually up a reasonable amount in my portfolio. This despite the fact that Newcastle and PHH got clocked pretty hard, and the oil stocks I own, Mart, Equal and Pan Orient succumbed to the pressure of falling oil prices and oil stock malaise.
Is what happened yesterday the sort of rise I have been waiting for? While it feels like it to me, its impossible to say. What I do know is that the underlying conditions in Europe have been supportive of a rising gold price for some time now. To say that gold must fall with Europe (presumably because of margin calls) can only be taken so far. There are only so many margin calls that can be made before no one is on margin any more.
I have listened to twice and would highly recommend this interview given by Donald Coxe on the James Pulplava Financial Sense news hour. He said the following:
With the great gold mines they have 20 or 30 or 40 years of reserves and you are getting it for free. Gold prices voer the longer term are bound to go up. You don’t have to pay via a call option to own gold in the future, you are getting it for free with these great gold companies. This is an amazing investment opportunity. All you have to say is, it won’t be an amazing investment opportunity if no governments are running deficits, if the money supply growth is not above 3.5%, in which case you should not own gold. If that is what you believe is likely then you should not own gold. On the other hand if you believe that is about as likely as an invasion of spaceships from some remote part of the milky way, which is my view, then you should be owning gold. And the best way to do that is by owning the gold mines.
Before today the concern about gold, I think, was that the American economy was on the cusp of a robust recovery and quite truthfully, if the US can grow sustainably, it can solve a lot of its problems. What the job report yesterday suggested was that the recovery is not robust. It needs to be understood that there is the possibility that the US just continues to muddle. The job report today does not mean that the US is collapsing, as the stock market and bond market seemed to suggest it was.
The bottom line, I think is that gold is an asset negatively correlated asset to paper currencies, and as paper currencies lose their perceived value, gold must benefit. Gold miners remain a very cheap way to take advantage of this idea.
I own exploration stocks. However, I’m not so sure that this is a great idea. The price of gold (and iron ore) have skyrocketed, but I suspect that the exploration and mining stocks haven’t necessarily done as well as they should have. Gorton and Rouwenhourst and have found commodity futures have outperformed commodity stocks by three times (http://fic.wharton.upenn.edu/fic/papers/06/0607.pdf).
Sometimes it is hard to make money in mining and exploration. The price of gold has gone up more than 6X but production has remained steady ~2000. This is despite gold exploration being “subsidized” by the junior exploration lottery. With the miners it’s a different story… but not all of them will really make money. AEM for example has negative retained earnings (though that is mostly because they are unlucky due to the mine collapse).
2- Most gold mines aren’t going to have a 20-40 year mine life. Mines usually benefit from economies of scale (e.g. larger equipment needs less labour)… the higher the production rate, the lower the costs. Net present value is usually maximized when the mine life is somewhere around several years, though this varies a lot.
With a few rare mines, the operators keep finding more and more ore (e.g at the Witwatersrand mines they keep going deeper and deeper). So there’s a phrase that “good mines die hard”. This is only going to happen for high-grade mines. But more importantly, you have to look at it on an asset by asset basis. Mines vary significantly in their mine life.
3- It doesn’t seem like a lot of mining companies are buying back shares or announcing buybacks/NCIBs. (Personally I think that a lot of senior gold miners are still expensive.) Altius Minerals is not a mining company per se but they are buying back shares. Northfield Capital/Pinetree/Aberdeen International own mining stocks and are buying back shares.