This Could Send Gold Mining Stocks Soaring in 2016

Gold Mining StocksMore Upside for Gold Mining Stocks?

If nothing else, my ongoing essays looking deep into gold mining stocks—a sector I believe to be the most complicated and most interfered-with sector of all world markets—have suggested that, to the superficial glance, nothing in gold trading, or gold pricing, is precisely what it seems.

For example, one aspect of 2016’s market action that has many investors buffaloed is the crazy action in gold mining stocks, which, on the “up” days at least, has continually surpassed and exceeded the corresponding bullish action in the underlying yellow metal.

In a market known for algo trades, AI (artificial intelligence) programs, and rampant excess, the action in the miners seems more an example of the “madness of crowds” than legitimate risk-pricing…?

Is there possibly a way to justify the mining action using traditional (and conservative) P/E (price-to-earnings) analysis?

Gold writer and technician Adam Hamilton suggests there is. His recent analysis of the sector suggests that, assuming gold does not return to a bear market, the miners have indeed NOT gotten ahead of themselves, but are in fact reflecting real and legitimate value.

As the object of his study, Hamilton looked at the Market Vectors Gold Miners ETF (NYSEARCA:GDX), a proprietary index that features the so-called best of the senior gold mining stocks and can be considered representative of not only the current state of the sector, but also suggestive of where the sector is headed.

Interestingly, he started off his report by underscoring that current profit reports from companies are misleading in that they contain major accounting charges resulting from the multi-year negative gold price environment that, seemingly, dissipated in 2015. Hamilton noted that, assuming the bear truly ended last year, these less-than-spectacular reports are temporary and that critical fact should be well-considered by investors scrutinizing the sector:

“[…] regardless of what gold-mining executives believed about the gold-price outlook, they were forced to take big write-downs assuming $1,100-or-lower gold was the new norm indefinitely. These losses have no cash component whatsoever, they are truly an accounting fiction. And once assets are written down to lower carrying values, they are never increased again per conservatism no matter how high gold goes.

“[…] These massive non-cash write-downs, under the assumption gold would never rally again, dwarfed the impressive operating profits the gold miners were actually earning even in dark Q4’15. Thus this entire sector is now showing trailing-twelve-month accounting losses or small profits after these write-downs. But gold mining’s nonexistent and high P/E ratios mask what is really happening on the operating front. As these write-downs gradually roll off of the latest four quarters’ results used to calculate standard P/E (price-to-earnings) ratios, the gold miners’ P/Es will plummet dramatically to reflect their actual costs compared to the prevailing gold prices.” (Source: “2016 Gold Mining Fundamentals,” Safehaven, May 16, 2016.)

Hamilton also added the following metrics to his core analysis on gold mining stocks:

“[…] These elite GDX gold miners reported average AISC [all-in sustaining costs] in Q1’16 of just $833 per ounce! That was also a slight 0.4% improvement from Q4’15’s $836. Think about the implications of this important fundamental revelation. In a quarter where the average gold price climbed 7.3% to $1,185, gold miners’ AISC were dead flat! That means their operating profits improved dramatically in Q1, which (current) P/E ratios don’t yet reflect.

“[…] The GDX gold miners’ margins soared from $269 per ounce in Q4 to $352 per ounce in Q1, large 31.1% growth on that mere 7.3% advance in prevailing gold prices! And if Q1’s average all-in sustaining costs hold into Q2, gold-mining profits will continue to explode…the gold price has (so far) averaged $1252 so far in Q2. That implies $419 per ounce in profits, which is another 19.1% higher.

“[…] Just like during every past major bull market in gold, gold-mining earnings are rocketing higher far faster than the gold price. That’s simply the way the math always works due to the inherent profits leverage of gold mining to higher gold prices. As gold continues its long-overdue mean reversion higher out of the anomalously-low central-bank distortions of recent years, gold-mining profitability will soar incredibly.

“[…] P/E ratios will absolutely reflect this once Q4’15’s big non-cash write-downs roll off the latest four quarters’ results. Some companies’ P/E ratios will improve even sooner than Q4’16 since they took write-downs earlier last year instead of waiting until the end. So gold-stock valuations based on the standard trailing-twelve-month price-to-earnings ratios will certainly look radically better in the coming quarters.” (Source: Ibid.)

Readers who follow my regular contributions will observe that, as a former accountant turned gold mining stock analyst, Hamilton does not delve too deeply into the highly controversial “fundamentals” of just how the gold market fell into ruin at a time when demand for the yellow metal was rising…?

That is probably a good thing.

That’s because investment practice—good investment practice—is based both on a fundamental understanding of the underlying asset and a realistic approach to prices and earnings.

So in that sense, Hamilton has made a very valuable contribution to our understanding of the sector, an analysis that is independent of the issues of interference and repression and general monkey business that many writers—including this one!—tend to focus on.

Under these conditions, his positive assessment of the future earnings potential of the senior gold mining stocks (should the metal hold in its present range or move higher) is well worth your very serious consideration.

That view, along with the many essays on the ongoing shenanigans in the Gold Wars that I have offered—see, for example, here—should assist interested investors in forming a more complete picture of a complicated but potentially very profitable sector.