Mining for Gold on Wall Street

Many technical analysts are saying the gold and silver markets are “breaking down.” I say the precious metals markets are cracking up…with laughter at the monetary shenanigans going on in the US, Europe and elsewhere.

Sure, gold and silver have suffered a sharp correction over the last few weeks. But so what; corrections always occur during long-term bull markets. Gold and silver are still cheap, which means that long-term investors cannot afford to ignore the recent weakness in the precious metals markets.

The gold price, at $1,664 an ounce, is still well below the inflation-adjusted all-time high of $2,330. Likewise, the silver price, at $32 an ounce, could quadruple and still not reach its inflation-adjusted all-time high of $136.

These comparisons do not automatically mean gold and silver are a “buy,” but they do illustrate how much higher prices could climb over the near term simply to “catch up” with inflation.

Now add in the fact that the powers in charge of the dollar and the euro are losing control of the currencies they purport to control, and voilà, you’ve got all the ingredients necessary for a continuing bull market in gold and silver.

If, as I expect, gold and silver prices will resume their decade-long bull market very soon, gold and silver stocks may provide even larger returns than the metals themselves. A balanced long-term investment allocation, therefore, should include both bullion and stocks.

Admittedly, gold stocks have been a big disappointment during the latest phase of the gold bull market. For more than a year, gold stocks have been doing next to nothing, even though gold and silver have been trending higher.

“Gold-mining equities may be married to the gold price,” observes James Grant, editor of Grant’s Interest Rate Observer, “but the spouses are not infrequently estranged.”

Since the day the gold price first jumped above $1,000 an ounce on March 13, 2008, the yellow metal has soared 68%. But over the same time frame, gold stocks, as represented by the Philadelphia Gold and Silver Index, have fallen 3%.

No investor buys a gold stock to lose 3% while the gold price is soaring 68%.

Perhaps gold stocks are due for a change of fortune.

Gold stocks are very cheap, both in relation to the gold price and in relation to most fundamental valuation measures.

The chart below shows the price-to-EBITDA ratio of the XAU Index of gold stocks. This ratio is a measure of price-to-cash-flow and tends to illustrate valuation more accurately than the more familiar price-earnings (PE) ratio.

Today, the price-to-EBITDA of the XAU Index is currently around 6.7 times — the lowest valuation in a decade.

The Price-to-EBITDA for the XAU Index of Gold and Silver Stocks

For example, based on enterprise value per ounce of gold reserves (proven, probable and inferred), a buyer of the gold stocks in the table below would pay anywhere from $81 an ounce (AngloGold) to $224 an ounce (Goldcorp) for the gold these companies have in the ground.

The Value of Several Large Mining Companies, Relative to Metal in the Ground

Expressed another way, the enterprise value of AngloGold is only 4.9% of the value of its gold in the ground. Most large silver companies are also selling for pennies on the dollar of their in-ground metal.

Obviously, this very rough metric does not take into account the cost of pulling that gold and silver out of the ground. Furthermore, gold and silver mining companies always sell for deep discounts to the value of their metal in the ground. But today’s discounts are much deeper than they have been in several years.

If you don’t own gold stocks yet, now is a great time to buy them. And if you already own them, you should certainly hang on, or add to your favorites.

Gold stocks are cheap.


Addison Wiggin,
for The Daily Reckoning