Things That Make You Go Hmmm - Such As The Spread Between Gold And Gold Miners

From Grant Williams, author of Things that Make You Go Hmmm

Newmont Mining currently trades near a 52-week low and has a dividend of just over 3%. Newmont’s dividend is indexed each quarter to the average price of the gold it sells in that quarter with step-up provisions of a further 7.5c if the average gold price exceeds $1,700 in a given quarter and a further 2.5c should those sales average in excess of $2,000. The company has a cash cost of gold mined of around $650/oz and is working hard to lower that figure. Analysts figure that earnings will hit an all-time high this year of close to $5 per share. The P/E ratio? That would be 11x. The same metric in 2008? 30x.

Newmont Mining is currently trading roughly $20, or 40% below the average analyst target price of $67.23 with a yield 50% higher than that of the S&P500 and a P/E ratio 30% lower, while its price-to-book ratio, at 1.8x, is also extremely close to the 2008 lows.

If we revisit the performance of NEM, GDX and GDXJ when priced in ounces of gold, it becomes apparent just how beaten up this particular sector has become.

NEM and GDX are at levels comparable to the very depths of 2008 (chart, previous page) and, when comparing the state of the world now versus then, it is incredibly difficult to understand just why that would be.

Remember, in the Autumn of 2008, panic was at its zenith and good stocks were being thrown out along with bad as deleveraging took hold of the world.

Since then, a number of key metrics that directly affect the price of gold and gold miners have changed so it makes sense to see  where we stand:

Now, with that as a backdrop, and with the understanding that, as we approach the endgame for Europe, the choice facing those empowered to make decisions about how it ultimately plays out is actually a fairly simple one—allow massive, widespread sovereign defaults and a continent-wide bank-run or print unlimited amounts of Euros—is anyone still confused about how this will all play out?

Europe’s ‘leaders’ will NOT arbitrarily choose to inflict the pain necessary to deal with the current debt crisis when they have the means to print free money at their disposal and the only impediment to doing so is an as-yet undetermined percentage of 81 million German citizens. If Germany has to leave the EU in order for the moneyprinting to happen, then mark my words, they will leave—either because they choose to or because the ‘Latin-bloc’ (which now includes France) force them to. Either way, the end will come in a shower of confetti paper money.

There may well be a period of deflation or deleveraging prior to inflation taking hold, but with inflation the central bankers’ firehose of choice, we can be fairly certain that inflation is in our future and inflationary environments are good for gold. As for the period of deflation/deleveraging which we are seeing now, using the greatest deflationary period in history as our example would seem to suggest that gold stocks will perform extremely well under those conditions also.

The fact that gold stocks are behaving so poorly seems to be as a result of both misunderstanding and inadequate knowledge of history on the part of the vast majority of investors and, as we have seen with subprime, Greece, Spain, Italy and, one day, Japan, the UK and the US, nothing matters to anybody until it matters to everybody.

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