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Gold Stocks Approaching a Crossroads

Recently, the Erste Group published a 120 page report covering precious metals. The report contains an absolute treasure of analysis, figures and charts concerning gold and the gold stocks. I have selected a few of the charts which help us explain the current status of the gold stocks. Essentially, there is a huge divergence between financial performance and valuations. Ultimately, the performance of the shares over the coming months will answer the question as to the resolution of that divergence.

We often hear how difficult of a time some mining companies are having. Although that is true, the reality is present conditions for gold miners have never been better. Rising costs are a problem but margins for the large unhedged producers are at bull market highs (and likely all-time highs).

 

 

The rising margins explain the consistent increase in cash flow and net income (with a few bumps) as the chart below depicts. Cash flow and net income for 2012 will also reach a bull market high.

 

 

Given the high margins, cash flow growth and record earnings why are the stocks struggling and trading well off their highs? A major and often forgotten explanation is the current low valuations. Several months ago, the price to cash flow valuation of senior producers was equivalent to valuation lows seen in 2000 and 2008. No chart better illustrates valuations then this one from BMO Capital Markets.

 

 

Now let’s examine the current technicals and draw a comparison between today’s bull market and the bull market from 1960 to 1980. Below we plot the current bull market in the HUI (red) and the Barron’s Gold Mining Index (BGMI). There are some differences but also some similarities. Note that the level 170 was key support and resistance for the BGMI for nearly five years. Once the Bgmi broke 170, it was headed much higher.

 

 

One can better view the current key pivot point from the chart below. The 52-55 range has been key support and resistance for GDX since late 2007. If and when GDX makes a weekly close above 55, you can bet that the prognosis will look quite bullish.

 

 

The market is at an interesting crossroads. Financial results have been strong but valuations are weak. The market believes earnings and cash flow will decline and has priced in that outcome to some degree. Ultimately, this will resolve itself in one of two ways. Producer margins can decline which would impact cash flows and profitability. That would eventually lead to lower share prices and GDX could threaten a break below 40. On the other hand, should margins increase then share prices will explode higher from a compounding effect. Rising margins will generate stronger cash flow and higher profits and the low valuations will rebound as sentiment would normalize. This is the fundamental case for the next major breakout in the gold shares.

Given the technical damage from the recent selloff (which went a bit further than expected) one should not anticipate this crossroads to be resolved anytime soon. Think months rather than days or weeks. Ultimately, the shares will break 55 to the upside in 2013 thanks to the combination of a breakout in Gold combined with stable costs in 2013. In the meantime the shares will consolidate providing you time to do your research and find the companies that will lead the next leg higher and outperform. If you’d be interested in professional guidance in uncovering the producers and explorers poised for big gains then we invite you to learn more about our service.

Good Luck!

Jordan Roy-Byrne, CMT
Jordan@TheDailyGold.com

  • Rosco

    I’m not sure about your start point for the 60s 70s bull market. On the long term BGMI the breakout appears to be 1962 which would line up the 1970 and 2008 violent sell offs.

    As incredible as it seems this BGMI bull is better supported that the 1970s with an extension going above the equivalent 1968 consolidation point. The 1970 collapse hit 100 and the 2008 collapse hit 500 or 5 times that of the 1970 one. The recovery occurred faster post 2008 and again got ahead of itself. At present we look to be at roughly the beginning of 1974 as an equivalent point and about right on track.

    If we use the 5x theory as a target for the next move the BGMI hit approx 750 in late 1974, five times this is 3500 which lines up with the upper trend line.

    Interestingly we are also roughly at about the same point on the dow/gold ratio of 7.5.
    To hold the same course the ratio would need to fall to around 4. As I expect the FED will keep the DOW at present levels approx 14,000 this would give a gold price of 14000/4 of $3500 or near a double on present prices which is what occurred in 73-74.

    Further conformation is the BGMI/Gold ratio. This fell in 1970 as in 2008, recovered and then fell again to new lows over the next 3-4 years. Which is where we are now. At this point there was a spike in the ratio with the BGMI outpacing the gold price and recovering to roughly the ratio seen at the rally high after the 1970 and 2008 collapse, which is roughly 1:1 or BGMI 1 – GOLD 1 or 3500 to £3500.

    Strangely enough this would only work out if we had a constantly falling BGMI/GOLD ratio ie if the ratio was lower now than in the 1970s. And this we have.

    So I’m in agreement, and for this to hold true we would need to see some violent upward moves in both the gold price and BGMI the near future – say the next three months.

    For reference;

    The long term BGMI – http://www.bgmi.us/

    The dow gold ratio – http://home.earthlink.net/~intelligentbear/com-dow-au.htm

    and an interesting article by Steve Saville on the BGMi gold ratio. – http://www.kitco.com/ind/Saville/20120522.html

    For the sake of us battered junior gold holders I hope this bull market rhymes.

    Rosco

  • dan

    WHEN MANIPULATION EXISTS..CHARTS MEAN SQUAT…mining shares have been placed on the attack list…and until the scum bastards ,who are cited daily around all sites (yet as a group these leaders in the metals market,will not attack the scum).are put in jail the miners will go no where…no matter what…IMHO

  • http://twitter.com/TheDailyGold Jordan Roy-Byrne

    Not really….though why don’t you provide some links to this “recycled material” you speak of?

  • http://twitter.com/TheDailyGold Jordan Roy-Byrne

    Rosco, I agree…great work. Though I don’t think we need to see the violent moves in 3 months….I’d say sometime in 2013. If thats Q1 or Q2, Q3…I don’t know but certainly have my ideas…

  • http://twitter.com/TheDailyGold Jordan Roy-Byrne

    Manipulation is a fact of every market…screaming about it does not help anyone. Moreover, this piece shows that gold stocks are following a somewhat similar template. Many stocks have performed well in 2011 and 2012 (we’ve owned a few of them). Focus on market timing and stock picking and you’ll make money…that is more fruitful than worrying about manipulation.

  • tom wolford

    All of this hand wringing about margins and cost will be resolved when we get a much higher gold price, which I expect.

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