Gold vaulted above $720, then sold off to the $670s, before stabilizing. More consolidation is clearly required after the massive advance from $420 only a year ago! And as a solid support level emerges, investors will ask themselves how to assess gold mining shares in the current price environment. Here are a few thoughts. Two weeks ago, a number of analysts pointed out that gold stocks were historically very cheap relative to the bullion price. Canada’s BMO Nesbitt Burns, one of the firms that generally excels at gold analysis, bemoaned that “this is the first time we have experienced bear market multiples in a bullish environment.” After all, sector flagship Newmont Mining was trading at the same price it had commanded when gold was a paltry $540! The question analysts conveniently ignored was why this distortion was taking place. As we move forward, it’s important to consider the possibilities. One glaring reality is that gold companies have lost a significant part of their leverage to an escalating cost structure. Another is that most gold miners have been on a stock issuance binge, with the result that profits, production and reserve growth per share have disappointed, despite sharply a steadily climbing bullion price. And finally, the market may simply expect that a period of rest for the Midas metal is more likely than further advances. Despite that, I continue to view high-quality gold stocks with a friendly eye. The central reason is the US dollar, which sooner or later will have to fall a lot.
While I continue to expect good things for gold producers, I’ll take a pass on silver stocks. The reason? They’re way too expensive! Take the best known primary silver producer, Pan American silver, which is still losing money and trades at more than eight times its annual sales revenue. In contrast, leading base metals producers typically trade at two times sales. That means you’re paying an enormous premium for the mere fact that it’s silver that’s being mined. Of course, if silver holds more allure than copper, nickel or zinc for you, I respect that. But you can get the white metal without paying astronomical multiples, in its physical form. The new iShares Silver Trust is now trading in the US under symbol SLV and its expense ratio is a low 0.4%.
Has the bull market in commodities reached bubble proportions? I don’t believe so, but the correction I’ve been warning of is clearly upon us. The question now is how deep and painful it will be. Analysts will be watching carefully, both for signs of resilience or deterioration in commodity fundamentals and each group’s technical position. My own view remains unchanged. Raw material prices (especially those in the metals complex) have risen exponentially, which clearly poses a risk. On the other hand, many analysts continue to use very rational assumptions for the underlying commodity price when they value a given stock. Which means that numerous quality mining and energy stocks continue to sell at compelling prices, especially given the current correction. Consider also that the world economy is strong and that increasingly more of the world’s available raw material supplies are bid for by the emerging nations. As I’ve said before: if you aren’t positioned in the commodity sector, accumulate a meaningful position into weakness. Recent arrivals to Perspectives will ask how I quantify “meaningful”. When I first recommended an overweight in mining and energy three years ago, I thought 15% of total equity exposure was adequate. A year later, when it became clear to what extent the third world’s appetite for natural resources would grow, I increased that target weight to 25%. That is roughly twice the S&P 500 component of commodity based stocks, which is another way of saying that institutional managers still have a lot of buying to do.
Peter Cavelti’s background as a financial analyst and author spans 35 years and four continents. His grasp of global issues is extraordinary and his comments and books have been published internationally. He was president of Canada’s Guardian Trust and subsequently owned his own firm, which managed some of the best-performing natural resource mutual funds. Peter firmly believes that only an integrated understanding of geopolitical, demographic and economic events can lead to successful investing, and that is what his web service Perspectives is about. If you feel keeping on top of relevant global events takes too much time, Perspectives is for you. Whether it’s investment advice or political analysis, Peter offers his insights in concise and easy-to-read form. Best of all, Perspectives is free. Visit www.cavelti.com and sign up today!