Wednesday, October 6, 2010

Heretical Thoughts on Gold Miners

This story was linked to by WSJ columnist and investment book writer James Altucher.

Over the last few days, I went through over 90 precious metal miner presentations from a recent forum. The companies presenting ranged from the major majors to minor juniors (pre-production, spending your cash on drilling holes across the globe).
Here is what I found out:
-Every miner is undervalued compared to its peers
-Every miner is a steal at its 2012-2015 projected production level
-Every miner has multiple high-potential opportunities in the world's most prolific mining region
-Every miner has an experienced management team that has a history of delivering results
-Every miner operates in politically stable, mining-friendly jurisdictions
-Every miner has wonderful community relations
-Every miner is a low-cost operator and is also sure that their costs will continue to go down
-Every miner is drastically increasing both reserves and production, but overall reserves and production are expected to decline
-Every miner expects gold and silver prices to go up due to multiple, undeniable fundamental factors
-Every miner is unhedged (well, almost, there were 2-3 that were removing hedges)
-Many miners have brand-name investors that they are proud of

So, satire aside, can all be right? The answer is an obvious 'no' for some of the points, and a subtler 'no' for some of the others. Here is what I was able to surmise about the industry and its underlying dynamics.
-Demand for both gold and silver comes from two general sources: actual use (industrial apps, jewelry) or "investment." As investment demand has increased, so has the commodity price. It appears to me that investment demand for gold is about 3x the level it was at in 2006-2007. You don't have to be a market maven to know what happens to price when supply is relatively inelastic.
-Miners are generally levered to the underlying commodity price level, so the miners' shares have been going up as well. This also attracts attention, and additional investment demand for the sector. Again, you do not have to be a market maven to figure out the price dynamic in a relatively fixed supply environment.
-There has been phenomenal growth in the AUMs of ETFs such as GLD, SLV, IAU, PHYS, CEF as well as miner ETFs like GDX, GDXJ, SIL, and broader "material" ETFs
-ETFs are just like many other asset management businesses, they do very well for their sponsors if AUMs grow; AUMs grow very well if the sector is doing well, so sponsors issue more shares and buy more of the underlying assets
-This is a positive feedback loop, and I am not sure that I like this dynamic longer-term, particularly for non-productive assets
-Imagine having a fund that accumulates residential lots in California, starting in 2002. The fund issues shares, and starts buying lots, moving the price up. Other market participants see that and start buying lots, too. The fund is doing very well because the underlying assets are appreciating. So they issue more shares and go back to the market for lots. The fund also thinks that every investor should have residential lots in their portfolios because they don't make land any more, while demand for housing is projected to increase for the next 50 years, real estate is a privileged asset class, expanding home ownership is a national priority, most millionaires come from real estate, etc.etc.etc. You get the picture and you know how the story ends. It is not a perfect parallel but there are some striking similarities.
-So increased investment demand moves up the underlying PM prices, charging the miners higher. With miners being higher, now there is a 2nd level of investment demand, that of the miners' ETFs + everyone else who wants in. Does it mean that the feedback loop is accelerating? Possibly.

More importantly, does it mean "sell now"? Absolutely not. I do not have a price target for gold (and, hence, miners) because I cannot estimate for how long central banks and governments around the world will continue with their inflationary policies. I would think that most of the appreciation in PMs/PMMs between now and "the peak" will be due to psychological factors, and, by this stage, there are no milestones for them.

Full disclosure: both BCIF and I personally are long miners of various sizes and precious metals, and short the Bernanke- Greenspan- Obama- Pelosi- Geithner- G.W.- Rumsfeld complex and everything it stands for.

1 comment:

Linda Laguna said...

This is a really important point. Everyone builds up their company, many using tired cliches, and mining stocks are no different. Each company must be evaluated on its own merits There are some similarities here. If every company claims that the prices for minerals will go up, then maybe there's something of note here. .