Massive Returns Expected From Gold Mining Companies

gold miningThe gold mining sector is both improving and selling for cheap. Don’t for a second buy into the mainstream rhetoric that states mining companies are worthless for your portfolio. They may be down-and-out now, but in the long run, they are setting up to provide massive returns.

Gold Mining Companies’ Valuations Extremely Distorted

As it stands, gold miners are selling for the same value, if not less, as they were back in 2008 and 2009. At that time, the gold price was at roughly $800.00 an ounce. This value should make investors question why this is the case.

See the chart below that highlights gold spot prices (golden line) versus Market Vectors Gold Miners ETF (NYSEArca/GDX) (green line)—an exchange-traded fund (ETF) that tracks the prices of gold mining companies.

Market Vectors Gold Miners Chart

‘Market Vectors Gold Miners ETF vs. Gold Spot Prices, Apr. 2007–Present,’
Chart courtesy of StockCharts.com

If you look closely, you will notice gold trades around $1,200. This is 50% higher than it was back in mid-2008. Mining companies tracked by GDX are trading few percentage points below what they were at that time.

I am not saying GDX is a great buy; I am trying to prove that there’s a massive disparity between gold prices and the valuations mining companies are currently getting.

Gold Miners’ Operations Improving

Valuations aren’t the only factor that make gold mining companies contenders for higher returns. When I look at their operations, I see them improving significantly as well.

I have said this before; I believe the decline in gold prices over the past few years has been nothing but a blessing in disguise. You see, this decline gave gold mining companies a wakeup call. When precious metal prices were rising, these companies didn’t care much about their costs.

Now, they are fixing the inefficiencies associated with their business. And they can’t get away with it anymore.

I follow the sector very closely; miners are reducing their production costs, their non-core operation costs are declining, their balance sheets are getting better, and for some, even their production is increasing.

This is impressive and something that’s needed in order to remain “in the game” in the long run.

One example of this is Lake Shore Gold Corp. (NYSE/LSG). In 2014, the company’s gold production increased by 38%; its all-in sustaining costs to produce an ounce of gold declined by 23%; it paid off a significant amount of debt; cash and bullion increased by 81%; and it turned profits. Lake Shore Gold earned a net income of $0.06 per diluted share compared to a loss of $0.56 per diluted share from the previous year. (Source: Lake Shore Gold Corp., March 26, 2015.)

Where Is the Gold Mining Sector Headed Next?

With all this said, let me also warn that not all the mining companies are great investments. I believe investors should be looking at individual companies and doing a significant amount of due diligence. There are still some inefficient miners who are simply vulnerable. Staying away from them would be the best option. Remember: patience is the key. Not being overinvested helps in case there is another downturn.

When the gold market turns, and I believe it will sooner than later, miners will provide leveraged returns. They are now much leaner, more efficient, and selling for extremely low valuations. Rising gold prices will result in higher margins. And this, in due course, will result in higher stock prices.

Gold Forecast Bullish for 2015-2016 by Michael Lombardi