May 26, 2022

Selling Climax in Gold and Silver Stocks Is a Classic Buy Signal

chartThe bear case for gold and silver stocks is well known and investors have reacted by dumping mining stocks indiscriminately.  The staggering decline in gold and silver stocks over the past two years now exceeds the decline that occurred during the crash of 2008 when the financial system was at the brink of collapse.

The Philadelphia Gold and Silver Index (XAU) is an index comprised of sixteen major precious metal mining companies. During the crash of 2008 the XAU declined by 58.5%.  From the peak of 226.58 in December 2010 to the low of 90.15 in June 2013, the XAU has collapsed by 60.2%.

Courtesy Yahoo Finance

Courtesy Yahoo Finance

Has the sell off of the past two years been so extreme as to constitute a selling climax which usually signals a major reversal from the lows?  According to John J. Murphy, an acknowledged technical analyst, a selling climax is “usually a dramatic turnaround at the bottom of a down move where all the discouraged longs have finally been forced out of the market on heavy volume.  The subsequent absence of selling pressure creates a vacuum over the market, which prices quickly rally to fill.”

It is too early to tell if prices have reached a capitulation bottom but investors who haven’t sold out positions in the precious metal miners after a 60% decline are probably thinking more about buying than selling.  Another factor that impedes future selling is the fact that investors are now getting paid to wait for a turnaround in the mining industry.

Historically, precious metal miners have never paid out large dividends but this metric has changed.  The stock price declines in  senior gold and silver producers have been so severe that the dividend yields on some gold mutual funds now approaches 4%.

The $2.4  billion Vanguard Precious Metals and Mining fund (VGPMX) currently yields 3.76% and holds a well diversified portfolio of seasoned mining companies.  The Vanguard fund holds investments in both domestic and foreign companies involved in activities related to gold, silver, platinum, diamonds, and rare minerals.

The chart on VGPMX looks like a reason for precious metal investors to commit suicide but if a selling climax has occurred, the losses of the past two years may be quickly recouped.  In addition, the chart of the Vanguard fund has made a triple bottom over the past six months.

VGPMX

Courtesy: Yahoo Finance

Another classic sign of a bottom in precious metal stocks was discussed by Mebane Faber who has drawn an analogy to the bottom of stock prices in early 2009 to the current chart of the Market Vectors Gold Miners (GDX).  In 2009 the S&P 500 kept hitting new lows even as the RSI and the MACD were making higher lows which is a classic bull signal.  A similar situation exists today with the GDX.

Courtesy: mebanefaber.com

Courtesy: mebanefaber.com

 

 

Why Gold Stocks Are A Better Value Than Physical Gold Or Gold ETFs

Many investors in gold mining companies are probably asking “where did I go wrong”?   While the price of gold bullion has moved relentlessly higher,  many large cap gold stocks have seen little or no price appreciation in recent years.

In a previous post, we examined the poor returns of two major gold stock mutual funds compared to the return on owning physical gold.  While the price of gold has soared 80% over the past three years, the three year return on the Vanguard Precious Metals Fund (VGPMX) was -.46% and the three year return on the Fidelity Select Gold Portfolio (FSAGX) was only 16.2%.

Why gold stocks have so badly lagged the run up in the price of gold remains subject to conjecture.  Some analysts speculate that investors prefer to avoid the risks associated with gold mining stocks and as a result have turned to physical gold and gold ETFs.  Since their introduction in 2004, gold ETFs have become very popular with investors, and now hold a total of almost $98 billion in assets.  By way of comparison, the market value of three of the largest gold mining companies, Barrick Gold (ABX), Gold Corp (GG) and Newmont Mining (NEM) total $108 billion.

If the gold ETFs did not exist, it is likely that some of the funds that flowed to gold ETFs would have instead flowed into gold mining companies.  However, the historical correlation between gold bullion and gold mining stocks has not always been perfectly linked.  There have been times when gold stocks outperformed or simply matched the price gains of gold bullion.

The recent under performance of gold stocks relative to gold bullion will probably not continue.  Many large cap gold mining companies are positioned to see significant increases in earnings that will eventually propel their stock prices higher.  Going forward, it is likely that gold investors will see higher returns on quality gold mining stocks than on holdings of physical gold or gold ETFs.

Two high quality gold mining companies previously featured in the GoldandSilverBlog that should see significant price gains are Newmont Gold (NEM) and Kinross Gold (KGC).

Newmont Gold is one of the world’s largest gold producers.  The Company has been increasing profits and production for several years and is forecasting an increase in gold production of 35% over the next six years.  Newmont has gold and copper reserves valued at $363 per share and pays a cash dividend of $0.50 per share which will be increased by $0.20 for every $100 increase in the price of gold.  Newmont shares closed on Friday at $52.10.

Kinross Gold had very strong first quarter results with revenue up 42% and earnings up 81%.  The Company’s cost of production is $543 per ounce and Kinross is forecasting an increase in gold production of 77% by 2015.  At the current price of $15.50 per share, an investor is effectively buying gold at around $250 per ounce.  Kinross Gold pays a dividend of $.10 per share.

The current pricing disparity between quality gold mining stocks and gold bullion has presented investors with an opportunity to purchase gold shares at deeply discounted prices.

Besides being able to effectively buy gold at a steep discount, gold mining companies pay dividends which are likely to increase substantially.   Another significant benefit of owning gold mining companies is the much more favorable tax treatment on gains.  Gold bullion and gold ETFs are taxed as collectibles at 28%, while the long term capital gains tax rate on gold stocks is only 15%.

Physical Gold Outperforms Vanguard And Fidelity Gold Mutual Funds

Investors in gold mutual funds have dramatically underperformed the return from holding physical gold over the past three years.  For a variety of reasons, many gold mining companies have been unable to turn higher gold prices into increased earnings.   As a result, gold stock mutual funds have dramatically underperformed the price gains of gold bullion.

Over the past three years, gold has increased by 80%, from a monthly low of $853 in May 2008 to $1,535 at today’s closing price.  Holders of the physical metal have done extremely well while investors in gold mutual funds run by two of the countries largest investment companies (Vanguard and Fidelity) have dramatically underperformed.

According to the Vanguard web site, the Vanguard Precious Metals and Mining Fund (VGPMX) has a three year average annual performance of -.46%, while the price of gold has soared 80%.  Vanguard states that although this fund is not a “pure gold or precious metals fund”, it invests in companies that are ” involved in the mining or of exploration for precious and rare metals and minerals”.  The Vanguard precious metals fund invests in 50 different stocks in 14 different countries and foreign holdings total 92% of assets.  The fund has net assets of $5.8 billion.

In early May 2008, the VGPMX reached $39 per share compared to today’s closing price of $27.20.  The fund has paid out dividends which added to the overall returns of the fund.

VGPMX - COURTESY YAHOO FINANCE

The ten year return on the Vanguard gold fund, however, would have outperformed holding physical gold.  A $10,000 investment in the Vanguard Precious Metals Fund made in May 2001, would now be worth approximately $76,300.  In May 2001, an investor could have purchased almost 38 ounces of gold for $10,000 which today would be valued at $58,330.  As noted above, the dividend payments by VGPMX added to the fund’s return.

The Fidelity Select Gold Portfolio (FSAGX) has outperformed the Vanguard fund, but still trails the three year return on gold bullion.  According to the Fidelity web site, the Fidelity gold portfolio had a 3 year return of 16.2%, compared to an 80% increase in the price of gold.

The Fidelity Fund invests at least 80% of its assets in companies involved in gold mining, exploration or processing.  The Fund also invests in gold bullion or coins and to a lesser degree, platinum, silver and diamonds.  The FSAGX has net assets of $4.5 billion.  The top ten holdings of the Fund at March 31, 2011 were Goldcorp, Barrick Gold, Newcrest Mining, Anglogold Ashanti, Newmont Mining, Kinross Gold, Agnico-Eagle Mines, Yamana Gold, Rangold Resources and Eldorado Gold Corp.  The total number of holdings of the Fund is 131.

FSAGX - COURTESY YAHOO FINANCE

The long term results of the Fidelity gold fund slightly trail the Vanguard gold fund.  Fidelity had a 10 year average annual performance of 22.54% compared to a return of 24.02% for Vanguard.   Both the Vanguard and Fidelity fund had returns that exceeded the increase in the value of gold over the past ten years.

Will physical gold or gold mutual funds deliver the best return going forward?

A continued rise in gold prices should eventually translate into higher leveraged profits for gold mining companies, unless the substantial costs of gold mining exceed the increase in gold prices.  Inflation is rapidly rising as central banks continue to flood the global economy with cheap money.  A continued rise in energy costs and general inflation could negate the benefit of increased gold prices for gold mining companies.  Investors who hold physical gold or invest in gold trust ETFs, rather than gold mutual funds, should expect to see continued superior investment performance.