Wednesday, June 04, 2008

A Gold Mine Is a Gold Mine Is a Gold Mine....

4 June 2008, expanded & updated 5 June 2008

By any metric, gold has done screamingly well since its early 2001 secular bottom.

Gold is presently trading at 3 to 4 times its early 2001 values.

By way of contrast, the Amex Gold Bugs Index (the HUI unhedged gold miners index) has not been able to hold its gains since May 2006.

Worse still, the SPTGD Canadian Gold Miners Index can demonstrate only paltry gains over the past 6 years - since May 2002. There were no gains at all from May 2002 through August 2007, and the recovery since August 2007 remains unspectacular. The SPTGD was stronger in May 2006 - at fleetingly-priced $730 gold, than it is today, at a stable $880 or so gold price.

The 6-year long failure of the S&P/TSX Global Gold (SPTGD) Index can best be seen in its literal collapse against the (US dollar-denominated) price of gold since May 2002. In that month, the SPTGD index was valued at 0.724 the price of gold.

Since that time, the relative value of the SPTGD index has steadily unwound against US dollar-denominated gold. The SPTGD:Gold ratio is now at levels that existed prior to the initiation of the present bull market in gold (a ratio of 0.356 - less than half its May 2002 level!). The decline has been particularly vicious since December 2006.

I have already discussed the impact of the appreciation of the Canadian dollar against the US dollar on Canadian gold mining shares during this period. At today's exchange rates, the Loonie has risen 58% against the US dollar, with its strongest rise in 2007 - which created an ugly year for the SPTGD index..

However, that appreciation does not fully account for the underperformance of the SPTGD index, which as you can see has depreciated by greater than 50% since May 2002 relative to US dollar-denominated gold. If this decline were attributable to gains in the Loonie, the Loonie would now have to be more than double its previous levels, or up greater than 100% against the US dollar. That has not occurred. As of today, the Loonie has climbed from 62 cents against the US dollar to 98 cents against the US dollar.

As is evident, Canadian dollar gold has climbed less than has US dollar gold - but not that much less! Canadian dollar gold bottomed at $390 per ounce in 2001 - compared to $255 per ounce in US dollar terms. But at present levels - near parity, Canadian dollar gold has still risen by as much as 165%. That gain has failed entirely to be reflected in the SPTGD index since May 2002.

In summary, there is not much to write home about on the gold mining front, either for Americans or for Canadians!.

Owning shares in the gold miners looks like a mistake - particularly the small cap mining and exploration companies, which have been decimated in the markets since May 2006. Losses on the order of 50-90% have not been unusual in the small cap precious metal exploration and mining sector over the past two years (though some small capitalization investments have done fine - which I consider a "tell" as to where the rest of this market will ultimately be headed).

As a poster child, let me bring forth the case of Nevsun Resources. Nevsun is presently developing the most readily available ultra-high grade gold deposit in the world in Eritrea. This deposit has essentially a million ounces of gold just sitting on top of the ground, waiting to be dug up and carried away. The Eritrean government - with one exception several years ago - has acted only honourably and in good faith, and is a large co-investor in the mine development process, helping to assure capital financing - which in this case is not even particularly expensive.

Yet the shares of Nevsun Resources have fallen from $9.25 in November 2003 to as low as $0.80 in August 2007. The shares continue to trade under $2.00 today, making the company worth a fraction (20%) of the value of its million ounces of gold - and still less than 50% of the value of its gold after recovery costs have been subtracted - and the rich underlying base metal deposits - in sum worth more than the gold - have not even been considered! Take my word for it - this market makes no sense - and Nevsun is a far more intrinsically valuable asset than is, say, Research in Motion - particularly when present market multiples of underlying assets are considered!

The gold mining business hasn't been friendly in Canada since May 2002.... It has seen six long years of sideways and often downward grinding action and concomitant frustration!.

But owning gold mining shares appears untimely only if you're thinking in terms of years - not decades.

This market started its turnaround in 2001. We are 7 years into a gold bull market, and at least in Canada, the gold mining shares have hardly participated since their May 2002 highs.

That is, there has been a 7-year gold bull market, but the Canadian gold mining market has so far participated in that bullish uptrend for only one year - from spring 2001 through spring 2002. Gains - where they exist - have been entirely modest (and certainly inadequate when the risk-reward profile is considered) since that time.
Investing in gold miners looks like a mistake - particularly if you're Canadian.

There has been more "gold" in speculative technology stocks such as Research in Motion than in the exploding (and much more fundamentally sound) gold market.

Why are gold mining shares so out of favour in the seventh year of a powerful god bull market?

There are many answers.

Obstacles exist at all levels.

The costs of mining are soaring, creating new barriers to entry. Everything is up - machinery, fuel, materials, replacement parts, and labour costs. For the Canadian miners, the rising Loonie has constrained rises in the costs of energy, materials and equipment, but not wages - which are up dramatically in US dollar terms!

Bear in mind also that what the miners are pulling out of the ground is rising in value more rapidly than the costs of producing it. It is just that up-front costs are now much higher, and this is what constitutes the real barrier to entry for small companies with limited access to capital

The longer-term XAU Philadelphia Gold & Silver Miners Index shows that gold mining companies were last popular in 1993 through early 1996, when gold was worth about $400 per ounce. At present levels, the gold and silver miners are valued only 13% higher in absolute terms than they were in 1996.

Account for the impact of inflation during that period - think for example of West Texas Intermediate Crude Oil rising from $20 per barrel in 1996 (and it was only $10 in 1998!) to $122 today - and you can see that the quadrupling in the US dollar price of gold since 2001 has had no appreciable impact on the valuation of gold mining companies since the beginning of 1996!

Small companies can't get capital to expand their exploration programs and to develop new mines. The US-initiated credit crunch has spread internationally, and Canadian miners are now experiencing greater difficulty accessing development and start-up funds.

Many large and intermediate companies are seeing their assets stolen or siphoned off by voracious or predatory governments (among which I do not exclude the Canadian government, spearheaded by Jim Flaherty, the Finance Minister and primary predator of the income trust sector).

For example, Venezuela's seizure of the assets of Crystallex and Gold Reserve is but the most obvious example of government exploitation of the highly vulnerable gold mining sector. Hugo Chavez' short-sighted and self-centred actions have led to the resignation of the President and CEO of Crystallex, as well as to a near total collapse in the share price of the company.

Larger cap Newmont Mining was besieged by the Indonesian government. Mining ventures in Latin America, Africa, the Middle East and Russia are all in question (though countries such as Brazil and Tanzania remain exceptions to the rule in these regions). Regulatory strictures block an untold number of developments in North America.

The Chinese appear to be the truest capitalists on the planet right now, but their country still has an authoritarian government, a brief record only of free enterprise, and over a billion people to feed, clothe and house. In balance, I feel safer holding shares of Jinshan Gold Mines, with all of its operations in China, than I do the shares of many North American-based gold mining companies.

Here's my take:

Investing in gold exploration and mining companies isn't the mistake it presently appears to be.

What's really going on is that we are caught up in the still very early stages of a multi-decade process.

If we're 7 years into a bull market, and if so little has happened during this period that 6 years of virtual inaction are still observable, then this is not going to be a "flash in the pan" bull market.

No, I'm thinking 2 and possibly 3 decades for this one.

It has now been 28 years since the last big bull run in the gold sector (in retrospect, 1996 was only a blip, undone by the final collapse in the market price of gold). And so far, all we have really seen is a brief jump in gold mining valuations from early 2001 to early 2002.

This is not a failed bull market. This is a bull market that has so many years ahead of it that up to this point it has hardly begun even to stretch its legs. There is more to come.

Much more.

Hang on.

Think decades, not years. Secular trends remain the most important factor in the formation of investment decisions.

Gold mining investors will be more than amply rewarded as the years ahead melt into decades.

It's going to be a long-term ride, so relax and don't rush. Take your time. You have all the time in the world - and it's all going your way.

Oh, by the way - I think six years of inaction may very well prove to be enough. My guess - 2009 could well emerge as another lively year for the Canadian gold stock sector - perhaps the most ebullient since 2001-2002. The time seems to be right for renewed action in the field of gold mining. So this year - 2008 - might yet be demonstrated to be a good one during which to stock up on gold mining shares.

Investing in gold mines could still prove to be... a gold mine!


  1. Never mind stocks, I'm going to pan gold in Bonanza Creek again next summer. This time I won't stop with just a few flakes. There's lots of gold and I'm gonna get rich.

  2. Since May 2002, going for the gold - and not owning the mine - has been your best option. So you are acting wisely. However, at some point - and possibly by next year - you would be better off to own the mine - with its implied future production - than to own the gold itself.

    Let's wait and see how that comes about. In fact, let's say I buy the mine and you pan for the gold. When the mining shares go up, I'll be charging you more for the right to dip your gold pan in the stream! That's basically how it works.

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