Gold & Precious Metals
For the first time in at least a couple of years, gold mining stock returns are outpacing those of the yellow metal itself.
As you can see in the chart below, the NYSE Arca Gold BUGS Index has given back 22.31 percent year-to-date (YTD), whereas gold has delivered 7.74 percent.
This is good news for both equities and bullion. When miners are doing well, gold tends to follow suit. Indeed, since the beginning of the year, spot gold has seen steady growth following a lackluster 2013. As I noted earlier in the month, it’s been one of the best-performing commodities of the year so far, a mere nugget’s throw behind nickel and palladium.
Miners restructuring their business strategy.
Gold mining, to be sure, is a tough gig. When gold prices are between $1,000 and $1,200 an ounce, miners barely break even in terms of cash flow.
Last year was particularly brutal. The metal plunged 28 percent—from $1,675 to about $1,200—which was the largest annual drop since 1981.
To reduce risk, many companies have cut costs in several ways. Some have decreased capital spending. Others have sold off assets. Others still have placed exploration on standby.
Case in point: Comstock Mining Inc., a young mining company which we own in our Gold and Precious Metals Fund (USERX), has managed to shrink operating expenses from $4.4 million this time last year to $3.8 million, mostly by lowering legal and advisory expenses. Other realized annual savings have come from administration and staff reductions.
In a recent interview with The Gold Report, U.S. Global Investors portfolio manager Ralph Aldis addressed the company’s rising success:
Comstock started production over a year ago at about 10,000 ounces a year. It doubled that and now it’s targeting a 40,000-ounce run rate in H2/14… The company has permits to reach 4 million tons per year so Comstock should be a 100,000-ounce producer by 2016. It’s a situation where people are creating value and [Chairman of the Board] John Winfield knows how to make money.
Time to wake up to gold-diggers.
An equity that has performed exceptionally well this year is Klondex Mines Ltd., headquartered in Nevada. Not only does it represent the largest position in both USERX and our World Precious Minerals Fund (UNWPX), but we also own it in our Global Resources Fund (PSPFX).
One of the main reasons we’re so fond of the stock is that in 2013, when the Market Vectors Junior Gold Miners Index was down 61 percent, Klondex was up 28 percent. It’s currently up 30 percent YTD and is targeting free cash flow (FCF) by the end of the year.
“This is a great story,” Ralph said in the same interview. “Most people haven’t woken up to it yet.”
Royalty companies are thriving as well.
Other players in the gold space that have flourished in this climate are royalty companies, which provide upfront capital to miners in exchange for a stake in future output. Since royalty companies avoid the costly rigmaroles gold miners must deal with on a regular basis—securing permits and building infrastructure, among others—they often receive a healthy return on their investments.
Two such companies are Franco-Nevada Corporation, based in Toronto, and Royal Gold, based in Denver. We own both in USERX, UNWPX and PSPFX, as well as our All American Equity Fund (GBTFX) and Holmes Macro Trends Fund (MEGAX). Whereas Franco-Nevada has risen 42 percent YTD, Royal Gold has leaped 70 percent.
Looking ahead.
Gold might have taken a minor hit this week, but autumn is right around the corner, when the gold jewelry industry traditionally replenishes its stock. And with unrest in Ukraine and the Middle East continuing to drive the fear trade, as unfortunate as these events are, gold prices appear buoyant.
This bodes well not only for investors in bullion but also mining companies, which will likely proceed with cost-cutting initiatives to maintain or expand margins.
Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by
Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk.
Gold, precious metals, and precious minerals funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The prices of gold, precious metals, and precious minerals are subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in these sectors.
Stock markets can be volatile and can fluctuate in response to sector-related or foreign-market developments. For details about these and other risks the Holmes Macro Trends Fund may face, please refer to the fund’s prospectus.
Because the Global Resources Fund concentrates its investments in specific industries, the fund may be subject to greater risks and fluctuations than a portfolio representing a broader range of industries.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.
The NYSE Arca Gold BUGS (Basket of Unhedged Gold Stocks) Index (HUI) is a modified equal dollar weighted index of companies involved in gold mining. The HUI Index was designed to provide significant exposure to near term movements in gold prices by including companies that do not hedge their gold production beyond 1.5 years. The Market Vectors Junior Gold Miners Index is a market-capitalization-weighted index. It covers the largest and most liquid companies that derive at least 50 percent from gold or silver mining or have properties to do so.
Fund portfolios are actively managed, and holdings may change daily. Holdings are reported as of the most recent quarter-end. Holdings in the funds mentioned as a percentage of net assets as of 06/30/2014: Klondex Mines Ltd. (1.34% in Global Resources Fund, 6.58% in Gold and Precious Metals Fund, 6.60% in World Precious Minerals Fund); Comstock Mining Inc. (3.57% in Gold and Precious Metals Fund, 2.12% in World Precious Minerals Fund); Franco-Nevada Corp. (0.53% in All American Equity Fund, 2.21% in Global Resources Fund, 2.45% in Gold and Precious Metals Fund, 0.55% in Holmes Macro Trends Fund, 1.16% in World Precious Minerals Fund); Royal Gold Inc. (0.58% in All American Equity Fund, 2.18% in Global Resources Fund, 3.14% in Gold and Precious Metals Fund, 0.59% in Holmes Macro Trends Fund, 0.91% in World Precious Minerals Fund).
These are four of the biggest threats to the bull market. According to Hugh Johnson Advisors, first is the threat of oil skyrocketing over the turmoil in the Middle East, and natural gas prices soaring as Russia retaliates over U.S. and European trade sanctions. Number two, interest rates surging as the Fed continues its tapering activities. The third threat is that the housing recovery drops dead. This could happen if fixed rates for 30 year mortgages rise above 5% by early next year. The next threat would be a stock market melt-up against the possibility of an unexpected jump in U.S. growth, in which case investors who are sitting on the sidelines could panic about missing out on the action and decide to jump in as the market reaches crazy heights. This could create a dangerous bubble as the exploding market leaves all thoughts of earnings behind.
Again, I note that most of the advisories are offering thoughts, scenarios, guesses and opinions about the U.S. and world situations. I prefer to stay with my main interest which is the action of the markets. As Barton Biggs in his great book Wealth, War & Wisdomemphasized, the stock market in its uncanny wisdom is always ahead of any single person or group. I’ve spent the majority of my life attempting to read the message that the market is sending us. In the investment business, the most difficult and least understood endeavor is the proper interpretation of the stock market Averages. Robert Rhea, the great Dow Theorist in the 1930s, once said the he was perplexed by the market 90% of the time. This was a modest statement by perhaps the greatest reader of the Averages I have ever come across. It’s no shame to be puzzled by the stock market.
Question: Do you have any prejudice toward this market?
Answer: I do. I want the market to remain bullish for the good of my kids and grandkids. I would like gold to remain in a trading range — preservation of capital!
It seems clear that the Fed will eliminate QE by October. The stock market must know this. I think this will be a case of hold steady on the rumor and this time buy on the news. Previously, when QE was reduced, the market sold off. But my thinking is that this time will be different. The news that tapering will be concluded by October will be greeted this time by a surge in buying.
So far the market is giving me what I want. A bullish trend with silver and gold holding in trading ranges. Is it wrong to have a prejudice regarding the trend of the market? In my case, I’m very aware of my wishes, but I continue to call the market the way I see it. One technical worry is that we now have 7 distribution days in the S&P and 6 in the NASDAQ This is telling me that money managers are taking profits and lightening up on their inventories. This is confirmed by the decline in margin accounts from recent record highs. Evidently the speculators are cutting back on their positions, which is probably a good indication that we’re not in a bubble.
The big picture: the stock market holds steady to mixed, while precious metals sit in their trading ranges.
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One of the great questions being debated right now is how will the market react once QE3 ends this October. Those who believe asset prices (namely stocks, bonds, and real estate) are being supported by the Fed, and not by underlying economic growth, expect a correction or worse once the Fed withdraws its support.
Richard Duncan summed up this view quite well in a recent Financial Sense Newshour interview, Prepare for a Correction Once QE3 Ends:
“[T]his is going to be a very interesting experiment because it will show us whether the economy is actually strong enough to grow by itself without government life support…and, unfortunately, I don’t think it is. For an economy to grow one or more of the following three things has to happen: either the workforce has to grow in size, wages have to go up, or credit has to expand. And, right now, none of those things are happening on a large enough scale to drive the economy… So when you remove the one thing that has been stimulating the economy and creating effective demand by pushing up asset prices and creating a wealth effect, when you remove quantitative easing, then where’s the new source of growth going to come from? I just don’t see it.”
Without sufficient credit growth in the economy, Duncan says that we’ll move back toward recession, which will then force the Fed to engage in a fourth round of quantitative easing:
“Once liquidity starts to dry up at the end of this year it looks very likely that the yield on 10-year government bonds will go up. That will cause mortgage rates to go up…the property market to come down, a significant correction in the stock market, a negative wealth effect, less consumption and, I think, then the US will start moving back towards recession. In other words, we’ll hit another economic soft patch and before that goes too far I think the Fed will once again have to jump in with another round of quantitative easing, QE4, to follow QE3 and QE2 and QE1. It will be the same pattern.”
This pattern of Fed launches QE – economy and stocks go up, Fed withdraws QE – economy and stocks go down is by now very well-known and expected by most market participants. In one sense, we might say it is the most obvious and predictable outcome. Will this pattern play out again or, as the inner contrarian in me always wonders, will the market do what we least expect?
This is where global investment strategist James Kostohryz comes in.
As we discussed in his recent interview, Stocks Likely Moving Into Bubble Phase Over Next Year or Two, what would happen if the economy and stock market fail to see, once again, the long awaited and much anticipated correction, even after QE3 ends?
If that happens—that is, we actually start to see sustainable economic growth and fears of a recession remain at bay—James believes the more likely outcome is that the stock market will enter a bubble as investor confidence really starts to take hold (note: to be fair, he actually makes a number of arguments why a bubble-like scenario in the stock market might unfold).
So, the big question is who’s right? Is the economy strong enough to finally wean itself from QE life-support or will we see the same pattern play out as before?
One of the best ways to answer this question is by comparing the strength of the U.S. economy today to when the Fed ended QE1 in 2010 and QE2 in 2011. Is the economy much stronger or more self-sustaining now than it was during those two prior periods? When we asked Ken Goldstein at the Conference Board this question, this is what he had to say:
“The answer is absolutely…the cycle is starting to move a little bit faster right now and indeed that’s what the leading indicators told us would be happening and now it’s telling us not only is it going to continue, but it might even start to pick up.”
In addition to the Conference Board, a number of other leading economic indicators have so far all come in positive for the month of July.
Here’s a table showing May, June, and available July data, which Jim Puplava covered in his most recent Big Picture broadcast.
Outside of the last two or three months, what is the direction of the larger economic trend? For that, here’s a chart of the Conference Board’s Leading Economic Index going back to the year 2000 (courtesy of Doug Short), which shows the economy has climbed steadily since 2009 and is not yet in danger of topping out and moving into a recession.
Below the Conference Board LEI is a chart of the S&P 500 over the same time period. Although some believe the market is a poor reflection of the underlying economy (and this may be true over the short-term), over the long-term there is actually a very close correlation, especially when it comes to major turning points.
Looking at the prior two cycles, you can see just how well bull market peaks coincide with a trend reversal in the Conference Board LEI. Typically, you want to start getting concerned about a major market peak once this and other LEIs breakdown.
At this point, however, the overall economic trend is still positive and does appear to be stronger than when the Fed ended QE1 and QE2. The end of QE3 could still cause market disruption, but, one thing is for certain, current and incoming economic data for the U.S. isn’t raising any red flags.
…is how anyone can even entertain the thought.
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