The beat goes on for gold, and even more so for gold miners. Although the commodity itself ended last week with a mere breakeven, the bigger trend is still a solid one — gold prices are up 16% since late June. Gold miners have fared even better; the Market Vectors Gold Miners ETF (GDX) has gained 28% in the same time frame.
Why are the mining stocks so much hotter than gold itself, and more important, how much further might gold mining equities climb before topping out?
As is always the case, that depends.
Shaken as Well as Stirred, But for a Good Reason
As I pointed out at the end of July, whatever gold does, gold mining stocks do it roughly twice as much. When the SPDR Gold Shares (GLD) gave up 32% of their value between September 2012 and late June of this year, the Market Vectors Gold Miners fund lost 60%. While gold values have rallied 16% between late June and now, gold mining stocks have soared as much as 37%, and still are up nearly 28% since then.
What’s the deal with the wild swings from gold miners? Simple. Almost every bit of every dollar that gold gains or loses in value is added or subtracted to a miner’s per-ounce (of gold) profit.
See, whether gold is priced at $900 per ounce or $1,900 per ounce, the cost for a miner to dig the stuff up is fairly uniform … about $1,200 per ounce. If gold prices can move from $1,500 to $1,600 per ounce, that 6.6% bump in gold’s value translates into a 33.3% improvement in the average miner’s net profit margins. But it works just as dramatically against the miners, too; a relatively small tumble in gold values can mean a large tumble in miners’ profitability. Ergo, gold mining stocks are stunningly sensitive to changes in gold prices.
And if it seems like the gold mining industry’s stocks have been even more sensitive than usual of late, you’re not imagining it — they have been.
The average “all in” cost of $1,200 to mine an ounce of gold wasn’t a hypothetical number. That’s the industry average, according to RBC Capital Markets. Goldcorp (GG) pays about $1,135 per ounce. Newmont Mining (NEM) says it spends between $1,100 and $1,200 per ounce to mine gold once all expenditures are accounted for. Gold Fields (GFI) reports all-in spending of $1,290, while Iamgold (IAG) expects to pay around $1,200 to $1,300 to keep its mining operations active through the rest of 2013.
Point being, $1,200 per ounce is a fair industry-wide yardstick to use when judging the viability of the sector as a whole, or when sorting out the winners and losers.
That $1,200 per ounce figure also happens to be right around the multimonth low gold futures brushed in late June. It was a low of $1,177, to be exact.
Yes, what you’re thinking is right — there was a point in time not too long ago when many of the mining industry’s players were selling gold at a loss, and would have been better off shutting down. It was only a temporary lull for gold, though none of us knew it at the time. At the time, all we saw was gold in a freefall, with no end in sight. That’s why gold miners fell so precipitously in the first half of the year, but it’s also why they have recovered so well since the end of calendar Q2.
Again, It’s All About Gold Prices
Go ahead and seek out the gold mining industry’s most investment-worthy names. Just know even the best of the best in the bunch are still going to be driven by gold prices — something entirely beyond their control — more than any degree of corporate strength or success. There’s a little good news on that front, though. Gold prices are in a strong technical uptrend, and have some room to run before hitting a wall and pulling back again.
To give credit where it’s due, Tuesday’s 1.3% advance in gold prices rekindled the recent rally at a point when many gold bulls were starting to sweat.
Although the commodity had been red-hot through Aug. 28, gold took three daily losses in a row from that peak, forcing many to wonder whether the party was over. It wasn’t — it just needed to take a breather. All gold needed to do was test the semi-critical price level of $1,383 per ounce (which had recently been a floor as well as a ceiling) before becoming recharged. With the tanks full again, gold can continue on to the ultimate target around $1,476. That’s where gold hit resistance in late April, and it’s where the 200-day moving average line will be by the time it can be tested again.
Once gold shoots the $1,476, I expect it to roll over — and that will be the end of the line for most gold mining stocks. If history is any guide, that tumble isn’t going to a slow-moving one either. It’s unlikely any of the miners will be able to shrug off that weakness … even the ones that can continue turning a decent profit at that price.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.