By: Quinton Hennigh
Many investors and speculators are deservedly frustrated and dejected by the recent performance of gold and, more specifically, the gold mining sector. For many of us in this business these ups and downs are the norm, however I see the current down as a critical one. Something is going to happen. . .a month from now, six months, a year or two, we can’t know. We may continue to see more pain in junior stocks until then, but a change is coming, and investors should take heed.
My views regarding the cycles in the world of gold mining crystallized during the time I had the privilege of working for Newmont Mining (NMC-T, NEM-N) while Pierre Lassonde was president. His views on the Dow to gold ratio and what it says about megacycles in the economy and the gold mining sector (detailed in his book The Gold Book, The Complete Investment Guide to Precious Metals) made sense of what I was seeing in the markets and major mining companies’ corporate strategies.
Figure 1 is a chart of the Dow-to-gold ratio over the past 112 years. The peaks generally mark points when the Dow Jones industrial average was running hot and gold was in the dumper. Conversely, troughs mark times when gold was riding high and the Dow was down. I have added a few interpretations to the chart. First, I projected this chart forward 25 years with a red line that I believe reflects a pattern that we are likely to experience, given a look back at history. Note that the red line bottoms out like the chart did in 1932 and 1980 and then slowly rises over the subsequent 25 years.
Second, yellow shading has been added to highlight periods when gold mining and exploration were generally more vibrant than other times. Yes, this is a bit subjective, but I see these as times when gold mines often made consistent money, the public felt comfortable investing in this sector, and perhaps most importantly, exploration was well-funded, thus contributing to a plethora of great discoveries.
At first glance, this pattern appears counterintuitive. One would think gold mining and exploration should proliferate as the price of gold is rising and the Dow-to-gold ratio falling. Instead, uncertainty and doubt rule as they do now: we are still climbing the “wall of worry.”
Vibrant periods in the gold world appear to commence around peak gold prices yet still persist as gold slides downhill! Answers to this conundrum can actually be seen in the world around us right now. The gold mining world is experiencing ever-increasing capital costs, unpredictable and almost universally high cost of production, and other uncertainties such as increasing taxes and royalties in countries eager to take advantage of the rising gold price. It is not a comfortable time to invest in this sector.
I do not profess to be an economist, nor do I know when this pivot point, the bottoming of the Dow-to-gold ratio, will happen or at what level. I simply see this pattern as rather compelling, and so simple even a geologist can understand it.
When mining companies are born
Mining and exploration trundle along during the “white” periods, but it is during the “yellow” times that things are really hopping. These are times when the “gold rush” mentality is alive; geologists are scouring new frontiers for fresh finds, and big discoveries are made, one after another. During the period from 1980 through 1997, for example, there was a succession of world-class gold discoveries: Hemlo (15 million oz); Goldstrike (60 million oz); Pipeline (12 million oz); Yanacocha (35 million oz); Pierina (9 million oz); and, Busang (the ultimate bubble top). These were discoveries that “made” companies.
Many investors scored huge returns on explorers who struck it big, while investments in majors also paid off. Believe it or not, Newmont was around $5 a share in 1983 and hit around $55 a share in 1996. Many other people made fortunes as Barrick Gold (ABX-T, ABX-N) moved to the forefront of major gold producers.
Looking back to the gold rush period from the 1930s through the 1950s, huge discoveries were made in the Witwatersrand of South Africa as well as numerous gold camps across the Canadian Shield. Again, these were discoveries that “made” companies. An investment in Homestake Mining in 1929 would have returned 600% by the late 1930s — during the Great Depression.
Looking still further back at the cycle that extended from the late 1800s through the early 1920s, gold rushes abounded in the western U.S., Australia, Canada, Africa. . . Great gold producers such as Homestake, Gold Fields (GFI-N) and Anglo American (AAL-L) made investors fortunes during this boom.
Figure 2 is similar to figure 1, but with the addition of the names of many major gold producers at the point when they were founded. Not surprisingly, most major gold producers have roots in these gold rush periods. Although there were miners that found their start during the “white” periods, most of these are no longer around, likely because they were gobbled up in the subsequent frenzy. It will be quite curious to see what happens to up-and-coming producers like Osisko Mining (OSK-T), Alamos Gold (AGI-T), and Allied Nevada Gold (ANV-T) over the next few years — do they get bought or survive through acquisitions?
If the next few years play out like I have tried to suggest they might through the long-winded history lesson above, we could be approaching a pivot point, one that ushers in the next “gold rush.” Given current market conditions this may sound crazy, but we could soon see a massive inflow of money similar to what occurred when gold last peaked.
Such a capital influx will likely accompany a sharp run-up in gold prices. Euphoria over gold, although probably short-lived, will pull in speculative money fleeing other sectors that are losing value. This influx of money will in turn feed the next cycle of discoveries and acquisitions as it did in the early 1980s.
Again, I don’t know when this pivot point might occur. . .a month from now, six months, a year or two? The significance of the cycles described above is that legitimately profitable deposits will be highly sought after as we roll into the next “up” cycle for gold acquisitions and exploration.
There are in the order of 2,000 junior exploration companies struggling to survive right now. They universally claim to be cheap and in possession of stellar projects. Some actually are cheap and a few do own above average projects. It is our conviction here at EI that the few companies holding exceptional properties and deposits will outperform the general junior market and be the target of larger mining company growth strategy.
— The author is an economic geologist who managed exploration projects worldwide for large mining companies for 15 years before joining the junior mining sector since 2007. He recently joined Exploration Insights, where this article originally appeared (www.explorationinsights.com).
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