Gold Versus Gold Miners: Has The Time Come To Flip The Switch?
Last October, among the various statements by Hugh Hendry at the annual Buttonwood gathering was this blurb by the man who is otherwise a big fan of physical gold: "I am long gold and I am short gold mining equities. There is no rationale for owning gold mining equities. It is as close as you get to insanity. The risk premium goes up when the gold price goes up. Societies are more envious of your gold at $3000 than at $300." Vivid imagery aside, he was spot on as the GDX tumbled 30% since then. Yet with the gold miners now universally abhorred and hated by virtually everyone, has the time come to take advantage of the capitulation? That is the question posed by John Goltermann of Obermeyer Asset Management, a firm better known for its deeply skeptical view toward Apple express as part of its April 2012 letter, and which also ended up being spot on.
Goltermann says: "Whatever the reason, the underperformance of the mining shares in the last 18 months has been significant. At this point, because of the price divergence, the valuation disparity, and general capitulating sentiment, there doesn’t seem to be a case for selling mining shares. Given the valuations, we are evaluating whether it is appropriate to add to the position. The negative sentiment towards gold could continue for a time, but as economist Herbert Stein cautions, “If something cannot go on forever, it will stop.” When price divergences like this occur, they usually self-correct. In the interim, there is a strong case that gold mining stocks are cheap and that much bad news is priced in." Then again, as Hendry said, it may just as well be insanity.
Curiously, in some ways Obermeyer's thesis is the opposite of Hendry's:
We don’t especially relish owning gold as it’s unproductive and is the antithesis of financing great businesses and ideas. But we also accept the idea that gold is simply money, readily exchangeable globally and a store of value that cannot be debased by governments. For this reason we believe it continues to have a place in portfolios at the present time. Many view gold as simply an inflation hedge, but it can also be effective during unstable times or when the prospects for financial assets deteriorate. Admittedly, with so much tentativeness on the part of investors and consumers, high unemployment levels, and the lack of pro-growth policies in Washington, the risk of rapidly rising inflation is low in the near term. But with debt growth far outpacing GDP growth (see chart below), the debt will most likely have to be monetized through Federal Reserve purchases, economic growth will have to pick up significantly, or outright defaults on entitlement promises will occur. All of these scenarios could benefit the gold market. In the nearer-term, because of the current trend in debt growth, some unforeseen crisis could arise prompting capital to flow rapidly back to gold and mining stocks.
It’s always hard to know the appropriate weighting of an allocation to precious metals, and in what form the allocation should be. We believe the right answer on allocation is more than zero. The precious metals market can be subject to wild price swings independent of the stock market because there are a significant number of leveraged speculators and hot-money investors involved and their behavior can’t be predicted.
The flipside is that Hendry's side has been proven correct and some would say, played out. And with most things (at least in the Old Normal) mean reverting, has the time for the alternative finally come?
Full letter below: