Gold Mining stocks appear undervalued. Should you load up...?
FIRST THINGS FIRST. Let's get a handle on what we mean by undervaluation, writes Jeff Clark, editor of Casey Research's Big Gold newsletter.
Gold accelerated higher last month, peaking around $1,900/ounce, while Gold Mining stocks lagged. Here's a chart of the HUI-to-gold ratio (HGR). In a rising gold environment, a climbing HGR indicates that Gold Mining stocks are outperforming the metal; a falling HGR means they're trailing gold.
Today's 0.33 HGR means gold stocks as a group have not been this cheap, relative to their underlying metal, since January 2010. And a lower ratio hasn't been seen since February 2009, when recovering from the 2008 global meltdown.
Also consider that the GDX (Gold Miners ETF) is about the same price as last December, while gold is up 30%.
I think there's a more compelling situation that demonstrates the undervalued nature of gold stocks. It's hard to read a mining company's quarterly report these days without hearing about "growing margins." The Gold Price has risen faster than operating costs across our industry and lifted profit margins of the better-run producers.
Higher margins are key to growing earnings and cash flow, which in turn lead to rising stock prices. Have Gold Mining equities kept pace with ever-increasing margins?
Gold Mining companies are earning record margins, averaging a whopping $1,268 per ounce last quarter. In both nominal Dollars and percentage above costs, margins have never been this high for the gold producers. Stock prices, however, have not responded in similar fashion.
This is a potentially significant point, because margins of this magnitude will be ignored only so long. When the broader investing community begins to take notice, investors will snap up these highly profitable stocks and push prices higher. The "catch up" in gold stocks could be tremendous.
The conclusions from these data seem clear: Gold stocks, as a group, are undervalued. The incredible profit margins generated by the sector will attract investors – sooner or later. And picking the better stocks is more profitable than buying a gold stock fund.
The question, of course, is timing. We don't know when gold stocks will begin to catch up. And the data don't suggest they must rise right now or that they've hit bottom. Contributing to their price weakness is concern that the recent surge in the Gold Price isn't sustainable.
The risk of another significant decline in the broader markets is a distinct possibility, and if one materializes, Gold Mining stocks could undergo a temporary swoon.
In the big picture, gold has ratcheted steadily higher throughout the rallies and corrections, a trend we at Casey Research are confident will continue for some time. As the price sets new highs and margins remain robust, the Gold Mining sector will attract more attention.
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