How does the prospect of making 200% in twelve months sound to you?
Far-fetched?
Well this is exactly what happened for gold stock investors between 2008 and 2009. The HUI gold stock index was intensely oversold in October 2008, and went on to soar 200% over the next year.
That was back then, of course.
But right at this very moment we’re looking at a near identical set up in the markets. Gold stocks are just as unloved and oversold. They’re at similar relative valuations. It won’t take much of a catalyst to see a serious move from here.
And it’s certainly not just me banging the golden drum today…
Last week in Hong Kong for the Mines and Money conference, I was extremely lucky to score a meeting with and interview keynote speaker and legendary precious metals expert, Eric Sprott…
An Investing Legend
Eric Sprott is the CEO and Senior Portfolio Manager of Sprott Asset Management, currently managing $11 billion in the precious metals markets.
With 40 years of experience making money in the precious metals markets, his views are worth listening to.
The good news is that right now he thinks it would only take a 6% move in gold, to pass $1700, to catalyse a massive move for gold stocks.
Our interview went for a full 25 minutes, on economics, politics, and the huge opportunity brewing in gold, gold stocks,silver, and silver stocks, as well as platinum group metals.
I’m working with my production team to get the whole interview out to you. It’s a tough ask in this short week, but look out for it on Easter Monday. Here’s a sample of what we talked about:
Alex: If we could move to gold equities, they’re at record lows whichever way you want to slice and dice them, whichever metrics you want to look at. Do you see an inflection point happening there soon?Eric: Well I’ve always said the stocks won’t go up until the metals go up, because everyone looks at the metal price and says, ‘Oh my god the price of the metal went down I don’t want to own the stocks,’ but typically when the metal goes up, the stocks outperform by at least two to three times, so if we can get a sustained move here – and we can’t just go to 1650 and give it up again, we’ve got to look like we’re going to a new high here, then of course the metal stocks have so much to get back again. And out of the 2008 bottom, the metal stocks put on a 200% gain…
I think that as [gold] approaches 1700, people will realise it’s going to be a sustained rally, and it’s not as though the stocks haven’t started moving already.
I mean they have, we had a day recently where the gold price went up half a percent and the gold stocks went up 2.5%, because they are so oversold here. Plus you’ve got short positions on them so there’s a bit of vulnerability from the guys that are short.
Look out for more from Eric next Monday.
At the conference, I also had my chance to get up on the stage and talk gold too. Part of my talk had been to remind investors what that move from the 2008 bottom looked like.
The 200% gain, or three-fold increase, during 2008/2009 was breathtaking. The increasingly realistic chance of a repeat of this is worth getting ready for.
And if you’re fed up of hearing it from me, then take it from Eric Sprott, a man who has invested $11 billion on this probability!
A tripling in gold stock prices wouldn’t be something to sniff at. However, the previous big move in gold equities, which started in 2001, saw the HUI index increase ten-fold. That kind of move isn’t just breathtaking, it can be life-changing:
HUI Index Increases Tenfold in Seven Years
Fantastic moves, no doubt.
Now consider that these charts show the HUI, which is made up of the big-cap gold stocks.
Small-cap and mid-cap stocks, the type I tip in Diggers and Drillers, stand to do better than 200%, or even 900%. As Eric told me:
‘The small companies always outperform the big companies, because they have more room to expand. I’d much rather buy a guy whose producing 100,000 ounces who can go to 200,000 ounces, ie who could double his income, than a major guy who’s at five million who thinks he might get to 5.5 million in three years, so there’s not the same growth element. So I always prefer the small to midcap guy, as providing by far the bigger return.‘
That’s something worth thinking about.
What Can Light the Spark?
But could we really be looking at a move of that magnitude from here?
What needs to happen to drive a major move in gold equities like this?
Some dividends wouldn’t go amiss, but that’s a story for another day. Before that happens, essentially the gold price needs to start rising faster than the production costs. This hasn’t been the case for a few years. Margins have been pinched, and gold stock prices have fallen as a result. I’ll explain why a reversal of this is possible in a moment.
First I’ll show you one more chart so you can see where we are in the valuation cycle. In short – we’re at the bottom of the cycle. Gold stocks don’t come much cheaper than this! This shows the HUI index divided by the gold price to show its relative valuation. Today it’s exactly at the same level it was in late 2008, as well as 2001.
The importance of this is that as you can see in the two charts above, late 2008, and mid-2001 are exactly when the last two major gold stock rallies started.
Gold Stock Index Divided by Gold – Telling You to Buckle Up, Buttercup
Of course you could argue that gold stocks are sagging because production costs are out of control? Indeed they are. In fact costs have increased by 256% in the last ten years. Ouch.
However, the reason for this is mostly because major miners have been mining super-low grade iron ore, which is expensive, to increase production volume. Rising labour costs, fuel costs, and costs of consumables like explosives haven’t helped matters.
But I can’t tell you how much grovelling we saw at the conference from the CEO’s and MD’s from the major gold companies about their costs. Each one promised cost-cutting programs, and a big change in strategy, focusing on profits over production volumes.
It’s probably no coincidence that we saw this grovelling, considering Barrick and Kinross, both top ten gold producers, fired their CEO’s for high costs in recent months. A whole swathe of other mid-cap gold stocks have followed suit since.
If the new guys, or any of the others who’ve hung on, actually want to keep their jobs – then cost cutting is mandatory.
They’ll whine that it can’t be done of course. Yet we saw gold companies cut costs by 25% between 1997 and 2001 – so it’s not impossible. On a positive note, a recent report by PwC researched the whole industry and reported this cost cutting has started.
It remains to be seen how successful this will be, but imagine if they come through with the goods, and gold sector costs actually fell, or even just levelled off.
And then imagine that gold also then hits a new high this year, as Eric Sprott and I both believe it will.
Gold producers’ profit margins will increase from the top and the bottom, taking them from ‘skinny’ to ‘obese’.
This would see stock prices do a massive U-turn from currently oversold levels, and a three-fold, 2008-2009 type, move for the HUI would be quite possible from here.
Then throw some dividend growth into the pot, stir vigorously and just maybe…a 2001-2007, ten-fold type move could be possible too…
Dr Alex Cowie
Editor, Diggers & Drillers
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