Back Up the Truck on Gold Miners
By Ben Abelson
21 Mar 2007 at 05:39 PM GMT-04:00
resourceinvestor.com
CHICAGO (ResourceInvestor.com) -- While gold stocks have had the classic reputation as an ‘alternative investment,’ the recent carnage in the global equity markets certainly didn’t leave the sector unscathed. Investors have fled gold and gold-related equities with a vengeance at several points in the past few weeks, as concerns over a subprime blowout leading to a global credit crunch led investors worldwide to raise capital.
The net result? Some of our favourite mining stocks are currently cheaper than they’ve been in a long time. In fact, the recent carnage make this one of the most attractive times to invest in gold stocks for long-term investors.
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Supporting this thesis is one of our favourite indicators of value in the gold mining sector - the Gold/XAU ratio. While previously discussed in great detail on these pages, the short of it is that the ratio measures the relative under- or over-valuation of the mining stocks to gold (a higher number = cheaper gold stocks).
With the ratio currently at 4.85, and having climbed above the 5.0 range on extreme weakness in mining shares last week, we’re at one of the cheapest relative valuation ranges in the past two years!
While it’s certainly a possibility that the mining shares could see further short- and intermediate-term weakness from here, long-term investors should be buying with both hands right now. (The last time we were this bullish on the back of the Gold/XAU ratio was in May 2005; witness the results).
A recent excerpt from the weekly comment by John Hussman, manager of the Hussman Funds, delves into the statistical backing for this analysis.
“To put some historical context on this measure, since 1974, the Gold/XAU ratio has been greater than 5.0 about 15% of the time. When the ratio has been this high, the XAU has followed with annualized gains of 89.6%, on average – a figure that remains high even if the data is split into multiple samples. When the ratio has been greater than 4.0, the XAU has followed with average annualized gains of 27.4% (though the finer profile of returns has been sensitive to other conditions such as interest rates, economic trends, and inflation). In contrast, when the ratio has been less than 3.0 (meaning that the gold stocks are very elevated relative to the actual metal), the XAU has declined at an annualized rate of -36.6%, on average.
“Importantly, the return/risk profile for precious metals shares is strengthened further if the economy is experiencing weakness. For example, when the Gold/XAU ratio has been greater than 5.0 and the ISM Purchasing Managers Index has been less than 50 (indicating a contracting U.S. manufacturing sector), gold shares have appreciated at an average annualized rate of 125.6%. In contrast, when the Gold/XAU ratio has been less than 3.0 and the Purchasing Managers Index has been greater than 50, precious metals shares have plunged at an average annualized rate of -49.9%.
“Such strong periods for gold are also generally associated with weakness in the U.S. dollar. Something to think about as the economic picture evolves in the months ahead.”
While Hussman is careful to note that such gains are obviously not guaranteed, his analysis does provide some insight into the favourable risk/reward climate that currently exists in the gold mining shares.
Putting Money to Work
While there may be some very exciting drill hole plays out there, the easiest (re: least risky) way to put money to work in this climate of undervaluation is to place bets on some of the cheaper producers on the market.
First on this list is IAMGOLD [NYSE:IAG; TSX:IMG]. While overhang from the recent Cambior acquisition, cost creep, and concerns of the development of Quimsacocha have been holding back the stock of late, the fact remains that this miner has solid assets, and is the cheapest mid-tier on the market right now, trading at about 1.3-1.5x P/NAV (depending on whose estimates you use).
It’s certainly true that cheap stocks often get cheaper, especially when there’s really no near-term catalyst to spike the shares higher (as is the case of IAMGOLD). Still, from a solely long-term (2-3 year time horizon), at $7.50 and change the stock is ridiculously undervalued – and is an easy bet to be trading above $15 at some point within that time frame. I’d recommend buying into it chunks, with an eye toward averaging down if the opportunity presents itself.
To me, the best analogue to where IAMGOLD currently stands is the shares of Northgate Minerals [AMEX:NXG; TSX:NGX] from mid-2005 to late-2005 (when the company was experiencing operational issues). While the shares flailed around under $2 for a long time (and went as low as $0.92), investors who loaded up throughout that range would’ve been pleasantly rewarded of late.
Kinross Gold [NYSE:KGC; TSX:K] is another favourite. After underperforming some of its higher-profile peers last year, Kinross’ shares have remained remarkably strong in the face of pressure on the overall sector in the past few weeks – and such favourable price action shouldn’t be ignored.
While we’re not a huge fan of the Bema acquisition (will Cerro Casale ever get built?), investors appear to disagree, and have been recently bidding up shares of Kinross so that it trades more on par with some of its large-cap brethren (at about 2.0x NAV). The stock has also recently seen a lot of institutional analyst support (the kind that was really instrumental in bidding up the shares of Goldcorp [NYSE:GG; TSX:G] last year, and Golden Star more recently).
We think the company’s strong growth profile and growing size (which should attract further institutional money) will help it continue to warrant a premium valuation above the 2.0x range. With Kinross’ shares staying strong of late (unlike IAMGOLD), we’re more confident that this story will play out sooner - and are currently long both the shares and out-month calls.
The ship’s finally come in for Golden Star Resources [AMEX:GSS; TSX:GSC], which we’ve been wildly bullish on since its sub-$3 days this past fall. Currently trading at about $4.22 per share, a detailed write-up on the company was provided last week. While the shares aren’t dirt cheap anymore, the stock has seen an unreal amount of institutional analyst support emerge in recent weeks.
Coupled with recent insider purchases, it’s a fair bet that this one has further room to run. Still, it’s our belief that this story is closer to the end than the beginning, so do exercise caution (i.e., trailing stops) if you get involved.
Conclusion
As a quick look at the charts of mining stocks over the past few years will tell you, entry (and exit!) timing is key when putting money to work in this sector. With one of our favourite indicators looking quite bullish, and several high-quality miners being priced at a discount, now’s the perfect time for investors who kept some of their powder dry to put it to work. |
