Tuesday, August 16, 2011

Big Mining Stocks Still Look Undervalued

It appears large-cap mining stocks haven’t quite caught up to the 2011 gold rush. Stocks of companies like Newmont Mining Corp. (NYSE:NEM), Barrick Gold Corp. (NYSE:ABX) and Goldcorp Inc. (NYSE:GG) seem to be correlating with the S&P 500 just as much as they are with the price of gold. Even with margin requirements lowering gold from its record highs, the increased margins for these companies should push them higher.

CompanyMarket CapTrailing Year Correlation –   GoldTrailing Year Correlation   S&P500
Some could view this table and argue that gold mining stocks have little correlation to gold, and therefore aren’t good investments to track gold. While the table does show that they haven’t tracked gold very well this year, there’ll have to be a period of catch-up.
With gold prices so outlandish, the margins for these companies will be greatly increased over the next quarter. The question is, can gold margins remain this high?
Gold Prices Experiencing Parabolic Seizures
There’s a ton of news reporting that gold prices are going parabolic. It almost sounds like some sort of seizure.
But if you can, think back to algebra class. That big hump-shaped graph for the quadratic formula was called a parabola.
And what these technical analysts are saying is that gold’s price is increasing rapidly. Eventually, the graph will look like the hump of a camel. What we don’t know is where the peak will finally flatten out and when the prices will come back to earth.
The CME’s move to increase margin requirements has certainly given a pause to the rise in gold prices. A similar move with silver margins in May caused a 30-percent decrease in the white metal’s value. That won’t happen with gold.
With the uncertainty in Europe and with the dollar, the markets have lost their heads. Nobody knows what to do. This volatility is pushing more and more investors out of the market. Cash and Treasuries don’t seem safe due to the combination of the downgrade and inflationary fears. So gold is the safe haven of choice for the world.
Price to Earnings
These gold mining companies still have low P/E ratios compared to the 2009 run-up in gold.
Company2009 P/E2011 P/E
As you can see, these companies are very cheap in relation to their P/E ratios in 2009. That year saw gold’s value rise past $1,000. Right now, it’s above $1,700. The margins for these mining companies will be outstanding if the price of gold can remain in this territory.
There’s also an ETF that covers large gold mining stocks like these: the Market Vectors Gold Miners ETF (NYSE:GDX). In the graph below, you can see how this ETF and the SPDR Gold Trust (NYSE:GLD) correlated strongly. Then, beginning in May, gold took off. Considering the past nature of these two stocks moving with each other, one would expect them to converge sometime soon.
Gold mining stocks get left behind as physical gold takes off
For now, it doesn’t look like gold is retreating any time soon. Even with a change in the margin requirements for futures contracts, gold is holding steady in the $1,700s. Some even see $2,500 gold by the end of the year. That may be a bit optimistic, but even gold in this vicinity is certainly a good sign for the margins of these mining companies.

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