gold mining stocks

I spent part of the day yesterday looking at gold mining stocks.

the potential attraction?  …over two years of dreadful performance.

Since mid-2011, the gold price is down by about a third.  Over the same time span, many gold stocks have lost between half and three-quarters of their value.  And that’s during a period when the S&P is up by about 50%.

Sentiment about gold has also taken a decidedly negative turn.  Hedge fund managers are no longer bloviating (how about that word?) about the superiority of the yellow metal over “fiat money.”  Boiler rooms are no longer filling the airwaves their odd sales pitch that “Gold has tripled over the past five years.  (Therefore you should) buy some now!!”

In addition, I think that 2014 will be a year of consolidation for the S&P.  So a 3% dividend yield plus the chance of, say, a 15% gain looks to me to be substantially more attractive than it might have been a year or two ago.

my verdict

I’m not so interested, for two reasons:

1.  I think the gold price is still too high.  In the past, the gold price hasn’t bottomed until it reaches a level where at least some existing mines become uneconomical.  This means that the cash a company must spend (not including non-cash costs like depreciation) to produce an ounce of gold is greater than the selling price.  As best I can tell (a long time ago, I would have considered myself an expert, but I’m certainly not one now), that’s below $1,000 an ounce.  The price may never get there, but, as an investor, I’m looking for situations with more upside than downside.  I don’t see that here.

2.  I don’t think companies have completely stabilized themselves yet.  The industry took on a lot of debt to fund what have turned out to be ill-advised capacity expansions at the top of the market.  That’s par for the course.

As far as I can see, these projects have by and large been at least temporarily mothballed.  However, there’s still the debt to deal with.  It isn’t so much that there are borrowings on the balance sheet that bothers me.  It’s that financially leveraged firms have to continue to mine in order to repay their lenders.  So supply isn’t taken off the market as quickly as it might otherwise be.  A number of companies had stock offerings last year.  Good for them, but this just prolongs the adjustment period.

All in all, I don’t find the risk/reward to be favorable enough right now.  Maybe in six months.