Fool's Gold Report: Miners Jump on Ukraine Tensions; Bullion Prices Mixed

Gold investors count on the yellow metal providing a safe haven during times of trouble, and with reports of U.S. fighters jets deploying to Poland amid Russian military exercises near the Ukrainian border, gains for gold would have been expected, especially with the Dow off more than 200 points. But gold's gain was actually small compared to yesterday's advance. April gold futures settled up just $1.90 per ounce to $1,372.40, and although spot gold fared somewhat better, SPDR Gold Shares (NYSEMKT: GLD  ) rose just 0.3%. Silver fared even worse, with May silver futures actually falling $0.16 per ounce to $21.20, sending iShares Silver (NYSEMKT: SLV  ) down half a percent. Platinum and palladium were little changed as well, even though mining stocks were up sharply as the Market Vectors Gold Miners ETF (NYSEMKT: GDX  ) climbed 2.5%.

Metal

Today's Spot Price and Change From Previous Day

Gold

$1,373, up $6

Silver

$21.22, down $0.11

Platinum

$1,472, up $4

Palladium

$773, up $1

Source: Kitco. As of 4 p.m. EDT.

Image sources: Wikimedia Commons; Creative Commons/Armin Kubelbeck.

How far can miners climb?
One aspect of the recent rebound in gold is that mining stocks have dramatically outperformed bullion prices. So far this year, the return of the Market Vectors ETF is roughly double what the SPDR Gold Shares have returned. To some who aren't familiar with the business model of gold mining, that seems like a possible sign of excessive gains for miners, which leads those investors to conclude that mining stocks' gains aren't sustainable.

But when you look historically, you find that these disparities are common in both directions. For instance, in 2013, mining stocks plunged much more than bullion prices, with even major companies Goldcorp (NYSE: GG  ) and Barrick Gold (NYSE: ABX  ) falling 40% to 50%. Similarly, during the long bull market that saw gold prices soar from below $300 to $1,900, many gold-mining stocks produced gains far in excess of the returns for bullion investments.

One key reason why miners tend to outperform bullion in rising gold markets is that miners' business models are inherently leveraged. As a simple example, if gold prices are at $1,300 per ounce and a miner's all-in cost of production and other expenses is $1,200 per ounce, then the difference of $100 falls through to the bottom line. But if gold prices rise by just $100 -- less than 8% in our example -- then this theoretical miner's profit doubles. Since stock prices tend to follow earnings, mining stocks magnify changes in gold prices in either direction.

Yet what you must remember about gold miners is that, counterintuitively, the miners with the best fundamentals -- high margins and low production costs -- won't necessarily climb as much as weaker, higher-cost miners. Again, in the example above, say a high-quality, low-cost gold miner has all-in total costs of $800 per ounce. In that case, a rise from $1,300 to $1,400 for gold prices would only boost this miner's profits by 20% -- much less than the 100% growth of the higher-cost miner. Yet as we discovered when gold prices plunged last year, higher-cost miners run the risk of insolvency and having to close down operations if prices fall below their production costs.

If prices continue to climb, then Goldcorp, Barrick, and other major mining stocks will not only see profits on their current production rise but also look at taking on more exploration projects. The resulting rise in revenue and profit could sustain a much larger increase in mining share prices than we've seen so far in 2014.

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  • Report this Comment On March 14, 2014, at 10:20 AM, TigerPack1 wrote:

    My suggestion and thought of the day is this:

    Up until now, most analysts and investors have priced gold based in a fiat currency amount, especially the world's reserve currency the last 80 years, the U.S. Dollar. We say gold is $1400 per ounce, for example.

    We often forget that gold has been (and will be) the ultimate currency throughout human history, and fiat (worthless paper) money comes and goes, at different rates in popularity over time. The biggest reason the U.S. currency lasted so long was initially from its "good as gold" status and gold exchangeable characteristics by central banks for nearly 200 years (with balanced fiscal budgets in Washington DC and trade surpluses with the rest of the world encouraging long-term investment).

    When we left the gold standard and convertibility expectation in the early 1970s, the value of each dollar collapsed vs. gold, as prices rose from $50 an ounce to $800 at the zenith in 1980. Considering the move from $50 to $1400 an ounce over three decades, the 2,700% gain in gold has proven America's fiat currency experiment a complete fiasco and disaster already.

    Today, the U.S. Dollar is not backed by anything but $18 trillion in debt at the Treasury (that can NEVER be mathematically paid back in constant dollar terms), and a PROMISE by the Federal Reserve to print many more of them each year, diluting the theoretical value of every fictional unit dramatically going forward.

    Perhaps we should retrain our minds to the reality that Dollars should now be priced in gold terms, the opposite of conventional wisdom, until now. Gold is not a regular commodity like wheat or oil, it IS MONEY.

    When an investor looks to "lock-in" his/her gains in gold or silver by selling it for Dollars, perhaps he/she is making a mistake. I propose we now price Dollars in terms of gold - today $1 buys 0.000714286 ounces of gold (less than a speck of gold to be honest). In a few years $1 will likely buy less than 0.00009 ounces of gold, or $10,000 of them will necessary to buy a small coin of gold.

    It's called slow motion HYPERINFLATION by the way.

    At this juncture in 2014, as the U.S. Dollar begins a momentous decline, smart investors should be looking to sell Dollars to acquire real money, namely gold and silver. They are the store of value you should be acquiring with your cash and life savings, if your intent is to hold value more than a few days down the road.

    Selling gold or silver today is very oxymoronic if you intend to retire in 5-10 years, or if you desire a spot to "hold" your purchasing power in a safe place. Holding large long-term savings, CD, annuity or bond investments denominated in the failing U.S. Dollar currency may turn out to be the WORST investment decision of your life going forward, especially at such low or next to zero interest rates.

    Retrain your thinking process America - gold and silver are the "money" you need to hold, not fraudulent promises of debt repayment or express promises to rape your savings in the future with yet more fiat money printing.

  • Report this Comment On March 14, 2014, at 10:50 AM, TigerPack1 wrote:

    Not surprisingly, the stock market is valued at about the same level as 1969, adjusted for real money changes in the gold price.

    Warren Buffett and Wall Street do NOT want you to know the S&P 500 has risen in price at a similar rate from around 100 to 1800 today. In all honesty, the $50 to $1400 gold price GAIN was BETTER than the increase in stock prices the last 45 years.

    The small saving grace for U.S. stocks and bonds has been the incremental interest and dividend payments each year of 3%-4% on average. Gold and silver do not pay interest when buried in the back yard. (If you have enough gold you can sell futures on it or forward contracts that pay interest however.)

    Nevertheless, this cocktail party comment may prove a good conversation starter - Did you know gold prices have risen faster than stock prices the last four decades? Hard to believe, but true sadly. When you adjust stock price gains vs. real hard money gains, stocks are the loser.

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