Last week, the lowest number of Americans filed for unemployment benefits since President Richard Nixon told the AP: "I'm not a crook" (November 1973). That is the sort of statistic that bolsters the case for the Federal Reserve to raise its policy rate as early as September, but equity traders are nonplussed on Thursday. The Dow Jones Industrial Average (DJINDICES:^DJI) and the broader S&P 500 (SNPINDEX:^GSPC) down 0.60% and down 0.51%, respectively, at 1:25 p.m. EDT. The growth-oriented Nasdaq Composite was down 0.34%.
Are gold miners a screaming buy?
Gold got a good start to the year in January, but it has had a rough go of it since then and the past week has been particularly challenging, with the price of the precious metal plumbing a five-year low yesterday. However, shares of gold miners have had it even worse. Shares of Barrick Gold Corporation (NYSE:GOLD) fell 16% on Monday to a 25-year low!
The following chart shows the year-to-date performance of the Market Vectors Gold Miners ETF (NYSEMKT:GDX) relative to that of the largest and most popular ETF tracking gold, the SPDR Gold Trust (NYSEMKT:GLD).
However, a five-year chart gives a more accurate idea of the extent of the carnage:
In fact, a Bloomberg article published last week observed that "mining equities are the cheapest relative to gold in at least thirty years" and that, furthermore, "the enterprise value of gold miners relative to their reserves and resources is the lowest in at least eight years."
That kind of observation can cause a contrarian, value-driven investor (like me) to sit up and attention. Are gold miners oversold and undervalued?
Unfortunately, price-to-earnings multiples are not much help as these deeply cyclical companies often sport high multiples even as the shares are depressed -- earnings have collapsed faster than the stock price (in some cases, losses mean the P/E mutiple is negative, which is also useless.) As of Jun. 30, the Market Vectors Gold Miners ETF was valued at nearly thirty times trailing twelve months' earnings-per-share.
(Note, however, that the ETF is now valued at less than six times cash flow!)
Price-to-book multiples are more useful and they suggest that some of the miners are indeed cheap. Take Kinross Gold Corporation (NYSE:KGC), for example, which trades at just 0.40 times its book value. That's lower than when gold hits its low of $251.70 in August 1999, the price-to-book multiple bottomed out at 0.55 during that quarter (but not as low as the 0.37 it hit in the fourth quarter of last year.)
However, keep in mind that distressed price-to-book multiples can reflect the market's expectation that the company will be forced to write its book value down or the risk of financial distress (the cheapest shares are generally those that belong to the most indebted companies; at the end of the first quarter, Kinross Gold had total borrowings equivalent to roughly eight times trailing twelve months' operating income.)
Which point brings us back to the original observation with which I kicked off this article: Gold miners are a leveraged play on the price of the commodity. This is due to the fact that mining companies tend to have high operating leverage (high fixed costs), which is compounded by financial leverage (these companies often make liberal use of debt in financing their operations.)
Indeed, according to data from Bloomberg, the Market Vectors Gold Miners ETF displays a beta of 1.68 relative to the spot price of gold over the period beginning in 2009, indicating that the ETF's returns are two-thirds again as volatile as the price of the precious metal. Furthermore, gold returns explain nearly sixty percent of the variability of the ETF's returns.
Given their dependency on the price of gold, this value investor cannot recommend gold miners as an investment per se, though I think the group could well make an attractive speculation -- provided you think the price of gold will reverse its trend of the last several years (I don't.)