Gold Miners vs. Gold Price

Gold Miners vs. Gold Price

Recently I had the choice of buying a new mobile phone, and being a trend follower, I came to the logical decision between a Blackberry and an iPhone. A year on I can’t help but notice how overpriced the former was considering the functionality, reliability and versatility of the other option, according to those who chose the iPhone anyway (and my Blackberry experiences). RIM are undoubtedly losing market share to Apple, and in hindsight the RIM team do seem to be pricing to a high end consumer that has since defected to a superior product.

Gold miners and the spot gold price are bearing a similar, yet totally opposite resemblance to this analogy, as the ratio of gold price : gold stocks price has risen over the course of the year. Gold miners are pricing in a low gold price that hasn’t existed in two years, and unlike RIM smartphones, are seriously undervalued. The two picks of the Australian equities are undoubtedly Newcrest (NCM, down 22% for 2011) followed by Kingsgate (KCN, down 43% for 2011), and overseas Newmont (NYSE NEM, flat) and select gold stock ETF’s also offer value in comparison with gold’s 16% increase over the same period.
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The Gold Trade

But seriously. Whilst the least risk adverse may be tempted to run a long gold equities position and rely on the politicians of the world to forgo their champagne fuelled game of European monopoly (it seems China has just realised the benefit of passing go numerous times), I myself would prefer to have a pairs trade which is also short gold bullion. I would be willing to take a 2.5-5% loss on the trade, depending on the portfolio goals, and would look to hold it until the ratio has sufficiently mean reverted (expecting 1-12 months, medium term).

As at 1/1/12

The Gold Trade Reason

The risk is that gold has indeed lost its shine, that the bubble has burst like a Kardashian marriage, and gold miners will never regain their high PEs that were underpinned by a stable and ever appreciating commodity. Some of this has already been unwound, and would be amplified should equity markets fall further, but not to the same extent that other materials stocks yet to experience this effect would decline.

At present, profit margins at NCM and NEM are the highest in years and production is always expanding (the recent rockslide shaved just 1.5% of 11/12 EPS). NCM produces gold at around $550 per ounce, with Q4 production rising 16%, as per its June guidance. The markets may not rebound in 2012, but gold stocks are likely to be the first to return to their previous ratios when some volatility leaves the gold price (those leveraged to copper, coal etc will rely on a recovery, gold stocks rely more upon stability), providing an enticing risk/reward ratio for the pair trade regardless of the movements of the gold price itself.

In the pipeline: Financial sector – high yields or growth stocks?

Bullish on: Gold stocks relative to gold (P/Es highest in a year)

Bearish on: 10yr US T-Notes (yields not justified by US fundamentals, low relative to SPX), USDJPY (strengthening of Yen on Japanese fundamentals)

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