If you have been reading either our blog or magazine over the last few months, then you’ll know just how vocal we have been about the mining sector and that we perceive, from an historic analysis perspective, that here is a generational opportunity to invest that has been forming during this period.
It’s true that we have been early here and have also been surprised at the ferocity and intensity of the bear run. In fact, over the last 6 weeks, the down draft has continued unabated and indeed accelerated, with many stocks, particularly in the gold mining sphere, falling to historic lows relative to book values and in some cases to not much above their cash levels let alone reserves and resource base values – in effect the market is giving you a call option on the continuity of certain companies and an uptick in the cycle for free.
If we look at the YTD performance for the various FTSE 350 sectors, we quickly spot the mining sector near the bottom – in the second worst position, and registering a decline of 27% YTD. Considering that out of 38 sectors there are only four declining, the mining sector performance is additionally shocking in relative terms.
What with the Federal Reserve still printing money (even if it is jawboning about withdrawing its continuation) and debasing the dollar, commodities should be a safe bet, eventually becoming more expensive in dollar terms but, as inflation hasn’t picked up (at least in official terms) to the degree one would have expected given the magnitude of money printing that has occured, the dollar has actually been pretty resilient this year and thus prevented metals from appreciating.
Now, with the FED threatening to stop its asset purchase program next year, the decline in metals has accelerated to such an extent in recent days that we can now currently buy gold at $1,200 and silver at $18.60 per oz.
A resilient CPI mixed with a QE-is-over threat has resulted in declines for gold and silver of around 27% and 39% respectively YTD – two of the worst performing asset classes out there. If we look at 2011 when those metals were trading as high as $1,909 and $48.50, one begins to comprehend just how badly precious metals have been performing. Since those all-time highs, gold is now down 36% while silver has lost 62%. We’re certainly in a bear market!
Now however is the time to take advantage of the old saying “don’t throw the baby out with the bathwater”. I’ve been in the markets long enough to realise that when there is utter despair, and valuations reach crazy levels, that it doesn’t last forever. Case in point was the aftermath of the tech boom when the Nasdaq index fell nearly 80%, the banking sector in 2009 when many stocks were similarly down almost 90%. Recall also the Russian markets collapse in the late 90’s and the Asian crisis around this time – yup, both down nearly 90% from the peaks, finally the Greek stock market in early 2012 – down also 90%. Spot a common theme here? Well, take a look at the GDXJ (the US ETF that tracks the gold mining juniors sector) – from its peak, you’ll see that it’s now down approaching…90%. One other common factor – the peak to trough decline typically took just over 2 years and yes we have reached and exceeded the 2 year point with the miners.
Coupled with price to books and EV/Resource basis even lower than in 2000/01 before the bull run begun, and sentiment through the floor, then you’ll see why we have been so vocal in recent weeks. History is on our side here in that yes, companies can and do go bust, but industry sectors, certainly commodity ones, do not disappear. Consolidation and the purging of the weak happens, and the remaining companies become stronger and prosper as the landscape is less competitive and the cycle inevitably turns. We are near the nadir in our opinion and this is evidenced by the unwillingness of many to invest.
Gold Miners Juniors 4 year chart
According to a study here (http://seekingalpha.com/article/1346991-the-true-all-in-cost-to-mine-gold-complete-2012-figures), which attempts to compute the real cost of producing gold by analysing 12 top mining companies, the real costs was around $1,287 for 2012. It means that at the current price level, gold miners en bloc are losing money, something which is an unsustainable situation.
For all those who think the gold bear market will push below $1000, we must say here that we don’t believe that’s likely, at least not for a prolonged period of time. If the cost to produce gold on average nears $1,300, and if gold prices dip meaningfully below this whilst physical demand continues to grow (which it is in India and China), then the market isn’t in equilibrium. Price declines must inevitably brake at some point and we think that time is close.
The main problems the industry have to solve are capital allocation and access to capital. Larger miners are now facing serious issues with regards to allocating capital into future projects. Their profit margins are being squeezed and it is creating a mismatch between long-term investment needs and short-term profit pressure. After 12 years of expanding margins, the industry attracted a new group of impatient shareholders hunting for high yield and abnormal short-term profits who have put pressure on the companies to achieve short-term results – something which may distort their long-term decisions, and thus destroy value.
The juniors certainly aren’t in a better position as many simply don’t have cash to bring mines to production and, in some distressed situations, working capital. Many of the smaller explorers run reserves of cash under just $1 million. With gold prices declining below the marginal cost of production, they need cash simply to hold tight but anxious speculators have trashed the equity of those companies which will make it even harder for them to borrow funds. Many will likely become insolvent and close their doors with the assets being sold to the stronger capitalised entities.
Expect companies with strong cash reserves to go fishing for smaller businesses with good reserves in politically stable regions (Canada for example) that just don’t have the resources to see through their mine plans. Some of the juniors may experience a three or four-fold rise in just a matter of a few years. The key here is to look for companies with good cash reserves, low debt levels and simple cost structures.
As in the late 90s, especially between 1999 − 2001, we may indeed be currently enduring a “nuclear winter” but can you guess what came after it? Yes, a 12-year bullish run. It always amazes me too just how, if you went into your favourite restaurant for a meal and the meal got progressively cheaper but the enjoyment was the same, just how pleased most people are. Ditto with cars and most goods – assuming quality stays the same and the price diminishes this is something to revel in.
Well, don’t ask me why, but when it comes to stocks (and to a degree housing) people don’t act that way. They fear falling prices instead of embracing them. The real money is made through flipping those hard wired human emotions on their head, investing in solid plays at exceptionally cheap prices and holding on as a bottom is made. We don’t profess to be able to call the bottom to the day, but on a multi-month basis (a bit like our Japan call last year, GBPAUD and USDYEN at the beginning of the year and the China play also last year where we were right but off a few weeks) we think the odds are massively stacked in our favour for price appreciation.
Our Precious Metal fund in our sister co Titan is being opened up to the public in early July and valuations, as relayed above, are even more compelling now to us. If you’d like to invest alongside us with our OWN MONEY, then email ‘Precious Metals’ to info@titanip.co.uk or click the banner below to submit your details.