-- Posted Friday, 23 March 2012 | | Disqus
By Chris Marchese
The above chart is a static model used to show just how undervalued the mining complex as a whole is relative to gold and/or silver. As seen in the chart above, the XAU is trading at an extreme undervaluation, nearly 50% as of the latest reading relative to the 6 year gold/XAU average. At first glance it would appear the ratio hasn’t seen these heights since the financial crisis of 2008. This, however, is a severely flawed measure of the utterly gross valuations in the XAU and the entire mining complex as a whole.
If the gold price & industry cash costs had remained unchanged, this would be a fantastic tool to determine over and undervaluation. But keep in mind the gold price currently stands more than $650 above the 6 year mean and more than 100% greater than the average gold price from 2006-2008. Yet, the Gold/XAU ratio has slowly trended higher over recent years, which should be indicative of lower industry profits or a rapidly rising XAU value. I think we all know it’s definitely not the latter. So it must be the former, right? Cash costs probably increased more than the underlying commodity price! Well not exactly, in fact, just the opposite. Cash margins have been steadily increasing over the past several years.
As seen in the two charts below, cash margins have been widening each year, meaning the appreciation in the price of gold has been outpacing the rise in input costs, especially over the last year+. There is also the possibility we have overlooked something, but the following charts only serve to reinforce the absence of any logical reason why the mining indices are lagging. In fact, all the charts in this article should be indicative of an index which should leave all others in the dust. While I have seen crazy things as an analyst for several hedge funds and currently for the Morgan Report [ http://silver-investor.com ] , this is most definitely the most illogical price behavior given the fundamentals I have ever witnessed.
Furthermore, in the mining industry, three or so models are typically used when appraising a mining company, notably DCF modeling, NAV premiums and P/CF. That being said, one can only draw certain conclusions about the gross underperformance of the industry as a whole. Also note, over the past 6+ years, the Gold/XAU ratio have never remained at suck extremes [ 1+ STD’s ] for such a prolonged period of time. Summing it all up, as far a valuation/relative valuation go…..
· Extreme readings comparing the XAU to the gold price
· Record Low Net Asset Value Premiums
· Insanely low Price/Cash Flow multiples – just 5x 2013 Cf’s
I find this very telling for several reasons.
· There is no gold or silver bubble
· The mania phase is still at least 1-2 years away
· A 25-50% rebound in the current ratio is likely to happen in the near future [12-18 months]
· Investors should wake up and smell the cash flows. The industry as a whole is spewing out free cash flow left and right but the supposedly astute investors [with obvious exceptions], has their head in the cloud, dreaming to invest in the next financial service firm to go belly up.
· As the equity markets go, current market prices are allowing investors to potentially make the investment of a lifetime.
· Value Investors have lost their way – SEE NAV Premiums
-- Posted Friday, 23 March 2012 | Digg This Article | Source: GoldSeek.com