by Dr. Mark Skousen, Investment U Contributing Editor
Wednesday, September 21, 2011: Issue #1605
Are you frustrated by the failure of gold mining stocks to keep up with gold?
While gold and silver are up 30 percent this year, the mining stocks continue to lag. Barrick Gold (NYSE: ABX) and Newmont Mining (NYSE: NEM), the two largest gold producers in North America, are break-even for the year.
Hecla Mining (NYSE: HL), the country’s largest silver producer, is down 35 percent even though earnings have doubled.
The Gold Miners ETF (NYSE: GDX) has been extremely volatile and is break-even for the year.
There are exceptions, but the overall trend is… well, trendless.
5 Reasons Why Gold Mining Stocks Are Lagging
To find out, I called the world’s expert on gold mining stocks, Rick Rule. Rick is President of Global Resource Investments (www.gril.net), a broker firm specializing in natural resources, and wholly owned by Sprott Inc, one of the world’s preeminent natural resource investment firms. I’ve known Rick for more than 30 years as a friend and valuable advisor… After our conversation, I came away with five reasons why mining stocks have lagged.
Typically, if gold and silver are rising, mining stocks are a leveraged way to profit. If gold goes up 30 percent, mining stocks could rise by 100 percent or more, because operating margins expand and profits skyrocket.
That’s not been the case, however. During the 10-year bull market in metals, gold increased six times its value, while major gold stocks maybe doubled. In the past year, you can see that gold ETF GLD is up more than 40 percent, while mining stocks, such as GDX, lag, up only 12 percent. (See chart below.)
Rick Rule offers five reasons for this disparity:
1. The introduction of the gold ETF made it easier for investors to invest in pure gold. Before GLD was available, investors had to buy physical gold through coin dealers or foreign banks.
2. Gold equities anticipated the run-up in gold prices five years ago, and the metal had to “catch up” to expectations already built into the equity markets.
3. Mining companies disappointed investors; they failed to perform in increasing free cash flow and profitability, relative to the rapid rises in commodity prices.
Rick ties this lack of leadership to the 20-year bear market in gold (1980 to 2000); the best managers went to more profitable opportunities (high tech, etc.).
4. The mining industry went through its own version of inflation, through share dilution. Market capitalization rose much faster than share prices, as companies resorted to issuing new stock to raise capital. (We’re seeing this share dilution especially in the rare earth and uranium stocks in the past few years.)
5. Up to 90 percent of all junior mining companies – all heavily diluted – are “no good,” according to Rule, and investors heavily discounted their value.
Why the Gold Market is About to Change
But Rick Rule has good news. While the competition with gold and silver ETFs will continue, mining companies are now inexpensive relative to bullion and investors will be rewarded accordingly.
Here are the four reasons why gold mining stocks are about to soar in the next few years:
1. After a 10-year bull market, good managers have finally returned to the mining sector.
2. Top mining companies are finally generating dramatically higher profit margins. Free cash flow is now “gushing” and will double in the next year as huge capital investments by the majors pay off.
3. Expect enormous consolidation as majors start buying up smaller producers, at startling premiums to current market prices.
4. New discoveries are expected as 10 years of new exploration is paying off, and the gains accruing to successful exploration efforts can be explosive.
How to Invest in Gold Mining Stocks
Rick is constrained by regulation from making recommendations.
However his clients report a fondness for:
- Perseus, Lydian and Esperanza among the developmental juniors;
- And Vista Gold (AMEX: VGZ) as an undervalued takeover target.
From my perspective, I like Newmont Mining (NYSE: NEM), which announced earlier this year that it would start paying out a substantially larger dividend and link its dividend to the gold price. It doubled its dividend to $0.30 per share two weeks ago. If gold exceeds $2,000 an ounce, it will raise its dividend to $0.50 a quarter, a 3-percent yield, the highest in the industry.