Why you don’t need PM mining stocks
Precious metals mining stocks are a popular recommendation in 2024, largely on the strength of gold and silver prices. I don’t think they’re quite what they’re cracked up to be.
First, let’s be clear about what they are. As I used to say in the early days of iTulip, gold mining stocks are not a kind of gold, they’re a kind of stock. They derive their value from expected future cash flows of a business. Of course the business benefits if the price of its products rises, but there are other major factors in the profitability of the mining business besides the price of the commodity being mined. One is the cost of getting the commodity out of the ground and to the market, which in turn hinges on factors like labor costs, energy and equipment costs. The business can be hampered by bad weather, strikes, confiscatory taxation or even nationalization, or just poor management. None of these are factors in the price of the commodity itself.
The usual basis for PM mining stock recommendations goes like this: The stocks have risen far less than the metals themselves and therefore have a lot of room to catch up. This line of reasoning is similar to that used to promote high flying tech stocks, in that it invokes serial relative comparisons without regard to the absolute. For instance an increase in Nvidia’s earnings is assumed to automatically justify an increase in its stock price regardless of whether it was already overvalued.
The case can be made that mining stock prices have not risen as much as the mined products because they were too high before, not because they’re too low now. Further that they’re still too high … just not as too high as they were before.
This case hinges largely on dividend yields. Dividends are the proper basis for valuing stocks in the aggregate, for the simple reason that they represent the cash flows investors actually receive. Use of earnings is often rationalized on the basis that retained earnings represent the company’s investment in future growth, and so are effectively just deferred cash flows to the investor.
While this can be and often is true for individual companies, it is not in the aggregate. This is another instance of the fallacy of composition I highlighted in How Markets Move. What is true of a particular instance is not necessarily true of the whole.
In particular, the question investors need to ask themselves is if these reported earnings are genuine profits that the shareholder should count as cash flows in valuing the stock, then where is the growth? We are told retained earnings are for future growth, but if you look at the industry as a whole over the long run they haven’t done anything but maintain their competitive position. Earnings that a business must spend to merely maintain the status quo are transparently not producing genuine growth. In the aggregate, corporations cannot grow their book of business in excess of overall economic growth. And most if not all of that is just population growth and inflation.
Using the ETF RING as a measure, gold mining stocks currently yield about 1.80%. This is derived from the fund’s reported yield and adding back the expense ratio. In other words, the average gold mining stock investment produces a real intrinsic return of about 1.8%. Or looked at the other way around, investors are paying 55.55 times their earnings for the shares.
In the scheme of things, while this might not be great, it’s not horrible either. So it would be exaggerating to say PM mining stocks have no place in investor’s portfolio. In fact I own some myself via RING and SLVP in an account that I don’t permit non-dividend-paying positions in (and which therefore excludes straight commodities, and they were bought at considerably lower prices). It’s not exaggerating to say though that the popular case made for them may be exaggerated.
Investors that like the prospects for precious metals should ask themselves why they would introduce extrinsic variables into the equation instead of just owning the metals. There are many good ETFs offering an efficient way to do this. The possibility of mining stock outperformance alone would just be putting greed ahead of risk and that’s often counterproductive. Individual stock investments are only justified after examining the company particulars including financial statements. And mining stocks should not be counted as part of a commodity allocation but as part of a stock allocation.
the major moves in gold have come from purchases in asia, especially including by central banks. meanwhile westerners have been selling. but central banks do not buy mining stocks; they just buy metal. i think this explains the lag in mining stocks. there is some evidence that the u.s. market has started awakening to gold. [these flows can be estimated by following the total cap of gld.]
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the only reason to buy pm mining or royalty stocks is to get torque on the price of the underlying metal. an increase in the price of e.g. gold will, pari passu, increase the profits of a miner by some multiple of that increase. e.g. if a miner makes $250/oz with gold at $2000, it will make $500/oz with gold at $2250. in this example the miner’s profit is up 100% when gold itself is up 12.5%
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historically, mining companies have used profits to dig more mines instead of getting that money to shareholders via dividends or buy backs. this is an intermediate to longer term risk with these stocks.
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personally i hold phys, which holds audited physical gold, as the foundation of my pm position. i have some miners as a more speculative holding on top of that foundation.
“the major moves in gold have come from purchases in asia, especially including by central banks. meanwhile westerners have been selling. but central banks do not buy mining stocks; they just buy metal. i think this explains the lag in mining stocks.”
Mining stocks have underperformed the metals because they were overvalued. This is a similar phenomenon to the underperformance of tech-telecom after the 2000 bubble. While it is true that westerners haven’t gotten fully into the gold buying act yet, correlation isn’t causation. Few westerners buy oil per se, but oil “mining” stocks have nevertheless done very well. While GDX is about flat over the past four years XLE has more than tripled. Even though central banks don’t buy energy stocks either. Not to mention miners aren’t even just western companies.
“historically, mining companies have used profits to dig more mines instead of getting that money to shareholders via dividends or buy backs. this is an intermediate to longer term risk with these stocks”
In which case they’re not genuine profits, but rather ongoing costs of sustaining the business, as I explained in the post. This is one reason they became overvalued; their true profits were much lower than investors gave them credit for. As a great investor once said, in the short run markets are a voting machine; in the long run they’re a weighing machine … markets eventually sort things out.
“the only reason to buy pm mining or royalty stocks is to get torque on the price of the underlying metal.”
Quite the opposite; it is a popular but bad reason to buy PM mining stocks and helps explain why their investors have so badly underperformed the metal. If that notion were valid they would have outperformed. As I explained in the post, they are businesses, with revenues, costs and financial statements. Investors that mindlessly buy them just as a form of leverage on their product prices and fail to do their due diligence on the businesses are vulnerable to the same pitfalls as those who buy highflying tech stocks without reading the financial statements or performing any valuation analysis.
Again, none of this is to suggest investors should or shouldn’t own mining stocks. It is to state that they should clearly understand that gold mining shares are very different things than gold. They are also absolutely different than a leveraged form of gold.
And like the dog that it is, Newmont Mining (NEM) fell nearly 15% today (Thursday, October 24, 2024) because of an acquisition that is proving more difficult than they anticipated.
While I tend to agree with that precious metals mining companies do give leverage to a bull market in the physical precious metals, they are infested with difficult to see landmines: lousy management, expropriation, “windfall” profits taxes, eco-terrorists, erroneous geological analyses, inflation in input costs, weather problems, infrastructure issues, ad nauseum.
I happen to own some shares of Newmont due to a mining company’s shares I owned that got acquired and acquired again before being acquired by Newmont. Despite getting burned in the 2000s [I managed to not make any money on buying shares in relatively large mining companies] precious mining companies are a surprisingly large percentage of my equity allocation because some of them do seem inexpensive.
I think the better-run companies with good mines in countries with better property rights will actually do quite well as inflation gallops and the prices of precious metals finally catch a bid. The critical trick, it seems to me, is to sell somewhat near the top if the equities enter a bubble or if there is no bubble but galloping inflation, to sell the shares before inflation in input costs consume too much of the margin.
I don’t think mining company equities are stocks that one would want to hold “forever.” 🙂
Right … to be clear, I’m not saying that mining stocks don’t have leverage to the price of the commodity; I’m saying it’s a bad reason to buy them. Grossly insufficient at best, because they come with a lot of other stuff besides leverage. If you want to leverage commodities, buy them on margin or use futures. Mining stock is stock, and requires the same kind of business and financial analysis as any other.
Newmont is as good an example as any. It sure didn’t tank 15% because gold prices are weak!
I’m not really trashing mining stock ownership in general either. I own some myself, but bought back at the end of February when they had a decent yield. Now that they’ve run up a bunch you don’t really get compensated to buy and hold. My beef is with shallow recos that say you should buy them just because they’ve lagged the metals, sans any valuation analysis.