If You Like Gold: Forget the Miners, Buy the Metal

December 09, 2013 0 Comments

For years investing in gold and gold stocks tested the most ardent goldbug’s faith. The great bull market that took the price from $250 to over $1,900 restored their belief in reason. After all, the Fed had gone wild since Nixon closed the gold window in 1971.

Fed Chair Ben Bernanke told the world and Milton Friedman the Fed would not make the same mistakes they made in the 1930’s. He said the Federal Reserve had the technology (not to mention the will) to create money and the central bankers turned central planners would create as much money from nowhere as it took to fill the lack of aggregate demand.

This all had to be great for the yellow metal and it was. The mining stocks, not so much.    Around Thanksgiving of 2008, the XAU (gold stock index) stood at 101, gold was $820. Today the index trades at less than 81 with gold priced at $1,227.

Jeff Clark, Senior Precious Metals Analyst at Casey Research believes now is “The Greatest Opportunity in 30 Years” to invest in gold stocks.  Now is the time to take positions that will make you wealthy. Clark cites resource investing legend Rick Rule who says often, “You’re either a contrarian or you’re a victim.”

There seems to be nothing more unloved than gold stocks and junior gold stocks in particular. The 23 year average for the ratio of the XAU to the gold price is 0.25. Clark writes, “Any time the ratio reached 0.20 or below, gold stocks were undervalued in relation to gold, and investors who bought at those inflection points made a profit. Conversely, once the ratio reached 0.34 or above, stocks were overvalued and due for a pullback.”

The current XAU/gold ratio is 0.07!  That’s after the barbarous relic has been pummeled by over 30 percent from its high. As bad as the market has been for the metal, mining shares barely have a pulse.

What gives? The Fed hasn’t started tightening. In fact, an even more dovish Janet Yellen takes the reigns of the central bank early next year.  Andrew Huszar apologized to the American people in an op-ed piece in the Wall Street Journal. He’s a former Federal Reserve official who oversaw the buying of more than a trillion in mortgage-backed securities as a part of the central bank’s quantitative easing program.

He says it became apparent QE wasn’t doing a thing for Main Street, but it is Wall Street the Fed looks to stimulate.  “Now the only obsession seemed to be with the newest survey of financial-market expectations or the latest in-person feedback from Wall Street’s leading bankers and hedge-fund managers,” writes Huszar. “Sorry, U.S. taxpayer.”

Huszar says America is overly dependent upon Wall Street for growth, and now QE is “Wall Street’s new ‘too big to fail’ policy.”  QE infinity is now a reality. This all should be excellent news for the gold price and the shares of companies that find gold and those that mine it.  It’s been anything but.

Well, that’s what being a contrarian is all about. The market is not recognizing value and you do, so jump on it.

Not so fast.

There’s a reason mining shares are trading at low values. Mining stocks analyst Jayant Bhandari says most gold companies “are truly in bad shape.” He says it costs $1,300 to mine and process an ounce of gold, more than the current spot price. It’s even more if you include sunk costs.  And then there’s that pesky thing called time. “Every day that is passing with gold at the current level, the value of mines is getting corroded,” Bhandari said.

Time and lower prices lead to mining company write-downs. Last year the industry wrote down $50 billion worth projects and large miners have continued the write down party in 2013.

 Many look to India to keep supporting the gold market on the demand side. Indians have an affinity for gold and the Indian wedding season is important to the gold market.  The country is the world’s largest gold consumer and doesn’t produce any.

However, the Indian government is trying to restrain the country’s current account deficit by taxing gold and limiting imports to 800 tons, a five percent drop from last year. Bloomberg reported that Indian purchases of gold and silver fell to $800 million in September, a steep fall from the $4.6 billion worth purchased in September of last year.

“The slide in shipments will comfort Prime Minister Manmohan Singh, who increased taxes on bullion three times this year to cool demand after buying helped to widen the current-account deficit and pushed down the rupee,” wrote Swansy Afonso and Unni Krishnan for Bloomberg.

Mr. Bhandari says the media has it completely wrong. Indians are buying all the gold they want via smuggling, but he sees bigger problems for the country. India’s economy is strangled by corruption that he says is cultural and can’t be fixed with government regulation. He sees the economy there stagnating with devaluations of the rupee forthcoming.

Indian workers are poorly trained says the investment pro who emigrated from India at age 36. The savings rate is falling and the cost of making anything in India is high he says. The country’s inflation is running over nine percent and Indians will keep buying gold to the extent they can. However, don’t look for Indians to keep buying as they have in the past because government bureaucracy, corruption and inflation make them steadily poorer.

Take it from a guy in the business of analyzing mining company shares, even at these low prices there is no value and little upside in gold shares. He says if you like the prospects for gold, just buy the metal.


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