Being a long-standing gold bull, I get at least a dozen gold research reports in my inbox every week.
Every now and then, you get one that warrants special attention.
The annual Erste Bank gold report is in this category.
It is a long read at 120 pages or so, but is written in plain English by Ronald Stoeferle, who has been picking the big trends for gold very well for the 6 years he has been doing this report. There are also enough charts in there to keep chart-nerds like myself busy for weeks.
This report comes at a good time. It gives good cause to hang on, just as gold stock investors are reaching ‘the point of maximum despair’ after more than 12 months of terrible performance.
Gold stocks have been crunched by disappearing margins thanks to rising production costs and falling gold prices.
Gold to Rally?
But some relief may not be far away. Although we are in a seasonally slow period for gold due to the Indian monsoon season, this could end as soon as next month. As Ronni argues:
‘The foundation for new all-time-highs is in place. As far as sentiment is concerned, we definitely see no euphoria with respect to gold. Skepticism, fear, and panic are never the final stop of a bull market. In the short run, seasonality seems to argue in favor of a continued sideways movement, but from August onwards gold should enter its seasonally best phase. USD 2,000 is our next 12M price target. We believe that the parabolic trend phase is still ahead of us, and that our long-term price target of USD 2,300/ounce could be on the conservative side.’
That’s great for gold bullion holders, but what does this mean for gold shares? These make up a large proportion of the Diggers and Drillers tips, from low-cost, dividend paying, growing producers, to an extremely undervalued, near-term producer and an advanced explorer.
‘We believe that the gold mining sector has a solid base. Although the pessimism is about as profound as four years ago, the fundamental shape of the gold industry is substantially healthier today than it was back then. Strong balance sheets, high free cash flows, a substantial increase in margins, low debt levels, and rising dividends all speak in favour of the sector. There are also only few sectors that are more underweighted by investors. In addition, it seems as if the industry has reassessed its former “growth at any cost” approach and is heading towards increasing shareholder value.
We believe that solid mining shares in politically stable regions currently represent a high-leverage bet on the gold price, with an attractive risk/return profile. We therefore believe that the current, historically low valuations offer a good opportunity to invest. At this point, we wish to point out again that we regard gold as a currency and thus as a form of saving, whereas we regard gold shares as a form of investment.’
The report includes a chart I’ve not seen before — not showing the data over such a long time frame anyway.
This chart shows 40 years of the valuation of the world goldmining index relative to the gold price.
Gold Stocks — So Cheap They Are Back to 1989 Valuations!
Gold stocks are back to GFC valuations. Or putting it another way, they are back to valuations last seen in 1989 — back when gold was $400 / ounce. Gold stocks would have to increase in value by 43% just to get back to the long term average. Yet they just keep falling.
This is obviously an unsustainable state of affairs.
Nothing stays this cheap forever.
Something has to give…but what?
Watch the Gold Miners
We need higher margins for gold stocks to command better prices. So either production costs fall (no chance), or the gold price rises (inevitable).
An interesting observation in this report was that there is good correlation between analysts revising their earnings projections for gold stocks, and turning points in the gold stock index. Analysts have been busy revising their gold stock profit projections down for 12 months now, and their bad news is slowing down. For the last 20 years, you can see this has signalled the start of the next leg up for gold stocks.
Gold Stocks (yellow) Tend to Rally After Long Periods of Analyst Downgrades (circled)
No one can say whether gold stocks will turn back up next week, next month, or next quarter. But the stage is definitively set for some real fireworks to happen, and soon.
The first chart above shows gold stock valuations over a 40 year period, but if you zoom in on what’s been happening the last few months, gold stocks may have finally found a floor.
This chart shows the HUI gold stocks index, which is a good representation of the whole sector. After falling for nearly a year, it has bounced from the current level a few times in recent months. This can be a good technical sign that the gold market has found its low point.
Gold Stocks – Finally Finished Selling Off?
Everything seems to be pointing towards gold stocks facing better times ahead. I wrote to Diggers and Drillers subscribers yesterday to say:
‘I wouldn’t expect all gold stocks to start recovering overnight, but it is worth keeping an eye on gold stock indices over the next month or two — to see if they continue to at least hold their ground around this level.
If so, then I’d be buying good gold stocks with my ears pinned back!’
Watch this space!
Dr. Alex Cowie
Editor, Money Morning
From the Archives…
No Mr. President, Entrepreneurs Did Build That…
20-07-2012 – Kris Sayce
How an Interest Rate Rise Could Trigger a ‘Punch Bowl’ Rally
19-07-2012 – Kris Sayce
When the Going Gets Tough, Entrepreneurs Innovate
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Is This Man the Ultimate Contrarian Indicator for Mining Shares?
17-07-2012 – Dr. Alex Cowie
How Gold Stocks Could Become Your Gilded Lifeboat
16-07-2012 – Dr. Alex Cowie
