As tumbling gold prices eat away at mining profits, a key metric shows that miners are more underpriced than at any point in the last decade. There are signs that the extended period of low prices will cause a supply contraction, causing both mining stocks and the yellow metal to skyrocket.
Gold has fallen a long way from 2011, losing more than 40% of its value in the past four years. Market Vectors Gold Miners ETF (NYSEArca:GDX), which tracks the value of gold miners, lost over 75% in the same period. Many analysts think the difference in magnitude is caused by widespread pessimism over the solvency of mining firms.
The argument appears straightforward: producing gold costs the same, but lower revenues mean companies are earning less money. The all-in sustaining costs, or AISC, for mining companies are around $920.00 per ounce. This is dangerously close to gold’s current level. And yet the AISC are probably even higher given that it doesn’t include tax expenses. (Source: Seeking Alpha, July 21, 2015.)
Gold Mining Stock Trade at Steep Discounts
One valuable metric that perfectly highlights the devaluation of gold miners is the GDX-to-Gold ratio, taken by dividing the price of a mining ETF by the price of gold.
Chart courtesy of www.StockCharts.com
Right now, the ratio is crashing to levels rarely seen before. The outsize depreciation of gold miners is leading some analysts to forecast a supply crunch. Low prices and high costs will cause many firms to shut their doors, and the resulting pullback in production will help buoy the yellow metal.
When the GDX-Gold ratio plunged last time, it was the result of a full-blown financial crisis that terrified all investors. Overreaction was endemic. But the ratio surged between 2009 and 2010 when the flight to safety finally kicked in. And now history is about to repeat itself.
Gold is up a little more than six percent in the last month, and the GDX is up nearly 13%.
Gold: The Stock Contrarian Investors’ Best Play of the Decade
The resurgence of gold has begun. Every day that we move closer to an interest rate hike from the Federal Reserve, markets become more likely to flee to safe haven assets like gold. The yellow metal is consistently an investor’s best friend because it is the ultimate hedge against economic calamity.