This article has been updated to identify a more direct play.
From the surface, a gold mine doesn’t look like much. I know, because I’ve seen lots of them up close.
Commuters in Johannesburg, where I worked on and off for two decades, get an eyeful on their daily commutes.
Immense piles of tailings hauled to the surface over the last 140 years dot the landscape on the city’s south side. You can see how the freeways wind around them:
Periodically, these mine dumps spring to life … a cascade of economic signals arrives from across the globe … and South Africa’s mining houses sift through the heaps for bits of the shiny yellow metal they missed the first time.
In some ways, the gold mining industry is as predictable as the weather. The gold price serves as its barometric pressure.
When that price rises, economic winds circulate through the mining system in regular patterns.
Understand those patterns — which I’ll explain to you below — and you have the key to profit from this volatile sector.
Metal vs. Miners
Recently, I mentioned in a Friday YouTube video that the gold price usually declines in the first few days after a market correction, as investors sell it to raise cash.
A few commenters responded that they had assumed that the gold price automatically rises along with risk in the stock market.
In risk-off conditions, gold resumes its upward march after a few trading sessions. But the fact that it dips initially as traders convert to cash for margin calls, or to pounce on value equity opportunities, is an example of the metal’s unique role in global markets as a store of value.
When it comes to gold miners, things get even more complicated.
For example, here’s a two-year chart of two common gold mining indexes versus the price of gold (shaded in blue). They track each other closely. Over the long-term, there’s no obvious advantage to owning miners versus their product:
But look what happens when you reduce the time frame to the last three months:
The price of gold has risen by a little over 15%. But an index of gold miners (red line) is up 21.5% … while an index of smaller, so-called “junior” miners (green line) is up over 40% over the same period.
Understanding why those performances differ so much is the key to profiting from gold mining investments.
Decoding Price Movements
All gold comes from ore in the ground. But as far as miners are concerned, that’s where the similarity ends.
Gold producers are broadly divided into senior and junior miners. Both are leveraged to the price of gold, but in different ways:
- Senior miners are large, established global operations. To investors, their value, and therefore their share price, is a function of the amount of gold to which they have mining rights, the quality of ore in their mines and their cost of production.
- Junior miners explore for new gold deposits and/or operate exploratory mines. Their goal is to find gold ore deposits substantial enough to attract a bidding war by the senior miners.
The share prices of the two types of miners react differently to the gold price.
All else being equal, when the gold price rises the senior miners who control lots of easily accessible high-quality ore see the largest share price increases relative to the other seniors.
The relative share price of junior miners depends on ore volume and quality as well, but also on the potential future costs of production.
When the gold price rises, junior miners with shallow deposits in countries with good investment climates outperform those with marginal deposits in difficult environments.
Added to this mix of variables is the expected duration of a rise in gold prices. Established senior miners who can ramp up production quickly and cheaply see bigger share price bumps than those who will take longer, at more cost.
For junior miners looking for buyouts, a higher gold price needs to be sustained to justify the capital investment required to bring the deposit into production. One-off price spikes due to geopolitical events aren’t enough.
Are We There Yet?
The key is that junior miners are much more leveraged to the gold price. When it rises, their shares outpace those of senior miners dramatically … as we’ve seen in the last 90 days.
That’s because their share price reflects the discounted future value of their gold output.
Investors will only pay a higher price for senior minors if they can add output profitably over the short term. At the same time, they are willing to reward junior miners for many years of potential future production.
But whether junior miners’ higher share prices can be sustained depends entirely on the medium-term outlook for gold.
That raises the question of where gold is headed now. If we can expect gold to stay at an elevated price for years to come, junior miners should be a hot investment.
As my colleague Clint Lee argued last week, signs suggest that the gold price will remain elevated for a considerable period. That’s because the key driver behind gold’s recent price rise is low-interest rates, as investors seek an alternative store of value to Treasury bonds that yield a pittance.
So with Federal Reserve Chairman Jay Powell assuring the world that the Fed is “not even thinking about thinking about thinking about raising rates,” I’d say now is a really good time to put some money into gold miners.
You can get your slice of the junior gold miner action by investing in the VanEck Vectors Junior Gold Miners ETF (NYSE: GDXJ). It’s up over50% this year and rising fast.
Editor, The Bauman Letter