Speaking with KWN’s Eric King, Euro Pacific Capital’s Peter Schiff recommends gold stocks at this time due to the meaningful lag of the sector relative to the high price of gold. Sign-up for my 100% FREE Alerts!
“I think if you look at the underperformance relative to bullion, they (gold stocks) are the cheapest they have ever been.” Schiff told KWN.
Anyone following Schiff’s commentary knows he’s liked gold stocks, especially as the gold bull market enters its second stage—a stage when hedge fund managers start jumping aboard more broadly in both the bullion and stocks.
One such manager, Greenlight Capital’s David Einhorn, has been getting lots of press lately for his decision to lighten up on gold bullion to buy gold shares for his clients. Einhorn has been a gold bull for several years, but he anticipates that after 30 months of poor performance of the gold stock relative to the metal the time is now to change to a faster horse.
“A substantial disconnect has developed between the price of gold and the mining companies,” Bloomberg News reported Einhorn saying in a conference call to investors. “With gold at today’s price, the mining companies have the potential to generate double-digit free cash flow returns and offer attractive risk-adjusted returns even if gold does not advance further.”
He added, “Since we believe gold will continue to rise, we expect gold stocks to do even better.”
According to Bloomberg, Einhorn has chosen the gold miners ETF, GDX, to expose his fund to the sector’s major producers. He still favors the metal, but he now wants to get more for his buck from the leverage to the gold price that gold stocks offer investors.
As with any stock, management and operation risks remain as primary concerns to investors taking on exposure to the gold bull market through the ownership of mining shares. Einhorn’s choice of mitigating that risk through the GDX ETF is a good one, in that a diversified holdings of the world’s major producers reduces his exposure to either a surprise nationalization of a mine somewhere in the world or some other negatively impacting event to one or two of the stocks which make up the GDX.
The graph, below, demonstrates Schiff’s assessment and Einhorn’s bet. The ratio of the gold price to the GDX has risen to approximately 30 while the gold price rallies to above $1,750. One would think the gold:GDX ratio would drop rapidly. Not yet.
Note the low gold:GDX ratio between the years 2002 and 2008. While gold traded below $1,000 (except briefly for a short spell in 2008), the gold:GDX ratio stood at below 20 nearly consistently throughout the six-year+ period.
Today, however, the majors have enjoyed bullion prices above $1,500 for quite some time. The gold price to the oil price is quite high, which is also favorable to the majors. Margins of the majors should be ballooning quite rapidly. It’s only a matter of time investors notice some pretty hefty earnings from the majors, decompressing those P/Es through higher stock prices. That’s the Einhorn bet.