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Mining Shares Trailing the MetalsChip Hanlon This morning's disappointing jobs report highlights what I and some others have been saying: the "strong" economic numbers we saw in the first quarter were a mirage. Bonds will rally on this economic weakness and gold, too, will rally as investors come to realize that even if the Fed does hike rates next week, this tightening cycle will be an aborted one; our debt-dependent economy only survives on the back of monetary inflation and cannot take meaningfully higher rates (for more on this theory, see my June 30th comment, "Bonds, Gold & Oil: More of the Same" in the commentary archives on our website: www.europac.net. So, if my past thesis is correct and the maintenance of generally low interest rates on the part of the Federal Reserve is mandatory with ongoing dollar weakness as the likely result, as seems so plainly obvious, what is the best way to gain investment exposure to gold? Of the two most common ways to gain precious metals investment exposure, through the purchase of physical metal or buying mining company shares, most analysts I read agree on one thing: "The mining shares lead the metals." I believe the opposite to be true. To understand where I'm coming from, a long-term look at a couple of key charts is necessary. First, here's a 15-year chart of physical gold itself:  As can clearly be seen, gold has risen from its recent depths back to the $400-ish level, an area where the metal spent 3 years going sideways in the early 1990's and one that is providing some measure of resistance today (which I'll get back to later). Now, take a look at the $XAU index of mining company shares over the same time period:  As can clearly be seen, this index is nowhere near the levels where it stood when gold was last at $400/ounce. Now, on the surface, this may seem a bit simplistic; components of the index have changed, the environment is different, etc. At the same time, consider: few industries have been forced to learn how to operate "lean" like the mining companies had to when gold was wallowing near $250/ounce. By controlling mined ore inventory, creating and standardizing focused machinery operations and through constant value stream mapping, these companies were forced to learn how to get the most out of their efforts. Such periods of pain, regardless of industry, set the table for fat years when conditions turn for the better, which they of course have for the miners. In other words: $400 gold is a lot more meaningful to mining companies today than it was 10 years ago, but the share prices of these companies don't reflect it. Even more than any fundamental argument of what mining companies are worth/should be trading for, however, this essay is about sentiment. I have long been arguing that the stubborn bullishness we have been seeing on the part of U.S. stock market investors since the bubble popped in 2000 makes perfect sense; after an 18-year bull market, investors have learned to "buy the dips," "get in and stay in" and to "be bullish on America." Undying faith is the natural residue of history's greatest bull market. Conversely, gold experienced the opposite over the same time period -- a crushing bear market. After nearly 20 years of pain, is it reasonable to believe investors will jump right back on the gold bandwagon at the first sign of strength? Hardly. As evidence, let's zero in on a shorter-term look at the same two charts above. First, here's a 1-year look at the metal:  All that has really transpired thus far in 2004 is that gold has paused near $400 -- it has effectively gone sideways. Now, here's the 1-year on the $XAU:  ...as the metal has consolidated, this index has at times been down more than 25% from its peak. At the first sign of weakness in the metal, investors abandoned mining shares; again, this seems to me the natural state of investor sentiment in the aftermath of such a long and torturous bear market. No one believes. For those of us who read and write alternative newsletters and follow the various gold websites regularly, we tend to feel that precious metals are very early in what will be a long-term bull market. We are also in the minority by a large margin. The vast majority of the investing public has no understanding of, let alone faith in, gold as an investment; I believe the still-tentative action of the mining shares, which is the way most investors will gain exposure to this sector, proves this point. If those of us in this minority are right, then we'll be handsomely rewarded over time as investors re-discover precious metals. However, let me make one last comment regarding what to expect from mining company shares in the near-term. First, I'm going to take it largely for granted that those reading this commentary understand the difference between owning physical gold and investing in the mining shares; there is a place for both gold, as the ultimate saver's protection against the debasement of our currency, and mining shares, which provide a leveraged speculation on a gold bull market, in most investment portfolios. Most of you reading this know, I assume, that physical gold should be owned first as a foundation, whether through an investment like our unique Perth Mint Certificate Program or some other means mining shares can then be added in an attempt to enhance portfolio performance. That being said, investors looking to buy mining company shares would do well to keep that $400-level in mind; again, in the early 1990's, the metal spent 3 years going sideways there. I have been warning that this area would act as heavy resistance and we are indeed more than 6 months into a consolidation I believe could last another year or more. If I am wrong about the length of this consolidation, I believe I'll be wrong with gold breaking out to the upside sooner than expected, so investors should be using this year's weakness in mining shares to accumulate positions, but they can likely afford to do so slowly, keeping in mind that if the metal continues to go sideways, these shares will probably weaken even further. Now, it should also be said that there is also a school of thought from some Elliott Wave types that gold actually remains in a major wave 5 to the downside which will culminate with the metal's final bottom back near or below $250. I don't subscribe to this theory since I think this outcome would require another deep recession (or worse) in which global economies ran off a cliff together and demand for commodities dried up across the board; I have faith that such a scenario would be met with predictable action from the world's central banks -- stepping on the monetary gas peddle, which is of course bullish for gold. No, I believe the worst case is a consolidation that lasts longer than investors expect. Investors siding with my thesis can decide on the amount of patience they wish to exercise while accumulating the still-unloved shares of the precious metals miners. Charts courtesy of stockcharts.com Chip Hanlon Mr. Hanlon
is the C.O.O. and Chief Domestic Strategist at Euro Pacific Capital,
Inc. in Newport Beach, CA, a full service brokerage firm specializing
in direct trading access to international markets. |
