The Shocking 15-Year Bear Market for Gold Stocks

Only a minuscule sliver of the so-called "smart money" has found its way into gold. Much of that bite-sized slice, moreover, has recently exited gold mining equities en masse as the entire sector has been buried alive. But when the smart money reacts predictably to near-term gyrations rather than long-term fundamentals, does it really deserve the name?

I believe the only move that the really smart money is making right now is toward gold rather than away from it. Gold continues to exhibit substantial resilience as it finds its footing around the $1,650 range, which gold expert Jim Sinclair correctly pinpointed as a significant price threshold more than a decade ago. I make it my business to understand gold, and I believe my conservative price target of $2,000 per ounce is already written in stone. In fact, I think it will prove laughably conservative.

The mining equities, meanwhile, have suffered a more noteworthy collapse that has rattled the confidence of many resource investors. Part of the collapse is rational, stemming from a combination of rising cost structures, unforeseeable setbacks that are the name of the game in mining, and isolated instances of poor execution.

But the bulk of the collapse, I maintain, represents a severe overshoot to the downside by a market conducting a grossly premature exodus from the metal and related miners. I offered similar arguments during the last major collapse in the miners, drawing attention to Yamana Gold (NYSE: AUY  ) at $3.85 per share and Silver Wheaton (NYSE: SLW  ) at its shocking multiyear low of $2.57 per share.

That's where you come in, because I think the supposed "smart money" is making another dumb mistake. In the wake of their overdone exodus, they have left behind a treasure in unmistakable bargains that will prove their value in spades during the next major breakout in the gold price. The precise timing of such a reversal is always hard to predict, but as a value investor I find reassuring safety in the depth of the market's disconnect from any semblance of fair value for these stocks. So just how deeply undervalued are these gold miners?

A picture worthy of a solid-gold frame
Through a recent feature blog post at King World News, GoldMoney founder James Turk released a chart that conveys the scale of the value proposition in gold stocks today more effectively and succinctly than I've seen it conveyed by any other means. Despite its cunning simplicity, the chart is bound to be a real eye-opener.

Turk's chart depicts the performance of the Philadelphia Gold and Silver Index, over a period of 30 years, expressed in terms of the number of gold grams or ounces required to purchase one unit of the index. Casual gold observers will no doubt be shocked to discover that the gold and silver mining stocks, when viewed in this instructive way, have suffered a major bear market decline over the past 15 years!

A unit of that gold and silver mining index is valued at just over three grams of gold today, the cheapest they've been in the past 30 years. Although the sharp rebound in mining stocks that followed the deep collapse of 2008 may have felt like quite a bonanza, when viewed in terms of gold it's clear that bullion has remained the vastly superior play to date. But gold bullion and the miners can only move in opposite directions for so long, and I believe, resolutely, that the quality miners will reclaim their rightful role alongside bullion as viable investment vehicles for the ongoing bull market for gold and silver.

Buying gold for $400-$800 per ounce
Gold commentator Gene Arsenberg believes that current equity valuations in gold, as measured by the NYSE Arca Gold BUGS Index, are more indicative of an $800 gold price than the prevailing price above $1,600. Major miner Goldcorp (NYSE: GG  ) , which carries the greatest weighting in that index, slipped beneath $40 per share recently after reporting a challenging quarter at its flagship Red Lake camp. I have explained before why I considered Goldcorp shares a gift to investors anywhere beneath $50, so bargain-hunting Fools can well imagine what I think of the opportunity here beneath $40.

The setbacks at Red Lake are momentary, offering long-term investors an unbelievable opportunity to climb aboard for the company's anticipated 70% growth spurt from 2.5 million ounces in 2011 to 4.2 million ounces by 2016. Goldcorp's stock is trading at less than 12 times estimated earnings for 2013; even as the world-class Pueblo Viejo mine that will propel next year's earnings growth is set to enter production within the next few months. Taking a moment to consider Goldcorp's looming production growth rate, peer-crushing cost structure, elite management team, and massive reserve base of 64.7 million gold ounces (with a current market value of $106.7 billion at $1,650 gold!), I believe savvy Fools will appreciate the tremendous value opportunity in these shares. I have retained a bullish CAPScall on Goldcorp since January of 2008. Incredibly, for all the interim strength in gold, the stock has advanced only 15%!

The industry's valuation disconnect grows more severe still with respect to the junior explorers and developers populating the Canadian Venture Exchange Index, which Arsenberg believes is pricing in gold "at $400 or less." It's true, the juniors have suffered an even greater decline than the majors here, and therefore offer potentially the highest-octane returns once this unsustainable disconnect reverses. The Market Vectors Junior Gold Miners ETF (NYSE: GDXJ  ) has nearly been chopped in half over the past year. Well-known juniors featured within that ETF include relative outperformer Endeavour Silver (NYSE: EXK  ) and future producer Rubicon Minerals.

I own shares of one micro-cap explorer that has located 1.4 million gold ounces in Canada's Quebec province, but trades at a market capitalization of just $12 million. At $1,650 gold, you do the math! I have examined multiple explorers with similarly promising finds that trade at similarly unfathomable valuations. Eventually, the underinvestment that coincides with such an impaired market condition is bound to filter back into the gold price, as without adequately funded explorers the industry will fail to locate new sources of gold to meet global demand. By the time the "smart money" does finally come to its senses and get itself into proper position with respect to the miners of gold and silver, the Foolish smart money will have smartly beaten them to it.

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Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Endeavour Silver, Goldcorp, Rubicon Minerals, and Silver Wheaton. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (48)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 27, 2012, at 4:07 PM, Diaph wrote:

    thanks for an article which is right on the mark about gold and the value of the dollar. however with all this bullishness, writers almost never mention the possibility of the government outlawing Americans' ownership of gold--as was done under FDR. one writer i read said this will happen again if gold goes over $2K/oz, and for the same reason--to protect our worthless $$.

  • Report this Comment On April 27, 2012, at 4:07 PM, toadaly wrote:

    I completely agree with this article. I backed up the Brinks truck this week to buy these stocks. The setback for GG was a technical issue they believe they already have solved. You have to expect some occasional issues with any mining operation.

  • Report this Comment On April 27, 2012, at 4:18 PM, dgrawr wrote:

    I have read recently about a factor that may mitigate the overdue recovery of mining stocks... and that is the cost of energy. it takes energy to produce the metals and the higher the energy prices, the lower the margins for the producers. This may have factored into the decline and may reduce rate of recovery (or the gold/miner ratio) over time.

  • Report this Comment On April 28, 2012, at 10:08 PM, SN3165 wrote:

    @gdrawr, The increase in the price of gold has far outpaced the cost of producing an ounce. There is a chart somewhere online that shows that margins have increased year on year. You should also give the royalty companies a look, they pay a fixed price per ounce of gold that they receive. Franco Nevada, Royal Gold, Sandstorm Gold, etc. For example, Sandstorm pays about $400-$450 per ounce of gold they receive. Again, that's a fixed rate. Great business model.

  • Report this Comment On May 02, 2012, at 10:41 AM, Bsav88atty wrote:

    Interesting article. Obviously, there will never be parity between the price of an ounce of gold and the price to buy one unit of the index. Much of this has to do with the cost per ounce and other dynamics involved at each, individual mining company (i.e., management, efficiency, profitability, mining region, etc.).

    It's completely understandable that the $400 price per ounce is being built into the junior miners. They are less experienced and many have gone deeply in debt and significantly diluted shares on their paths to profitability. Some of the juniors have entered financing deals with larger miners to provide a specific percentage of their gold production at fixed, discounted prices. Nonetheless, I believe many of these stocks are selling at big discounts. Indeed, some of them are priced for insolvency.

    Cheers

  • Report this Comment On May 03, 2012, at 6:06 PM, skypilot2005 wrote:

    Copper Fox up 10%, today.

    Up 40% since I read Sinchi's D. D. and pulled the trigger.

    There. Now I feel better after seeing all the red arrows in my portfolio.

    :)

    Sky

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