Gold Miners Forecast: Reversion Higher To The Mean

Friday, May 4, 2018

gold tunnel

Gold miners, the companies which extract the element from the Earth which has served as the backbone of the global economic system since the dawn of civilization, remain historically undervalued across two key metrics that are used to value the sector. Opportunity for profit exists for those with patience for the sector to revert to the mean.

First, gold companies are undervalued versus the broader US economy: a ratio of gold mining versus the S&P500 index is at its lowest valuation of all time. Secondly and perhaps more interestingly, gold miners remain undervalued relative to the price of the actual metal they produce: gold itself.

As contrarians, these are statistics we should pay attention to. Let us examine the charts.

Gold Miners Relative To The US Economy

The first way we will measure the gold miners is as a percentage of the broader US economy. For this comparison, we will view the XAU gold mining index relative to the S&P 500 stock index. The XAU is a basket of 30 companies which produce gold (and to a lesser extent silver), while the S&P 500 represents the 500 largest domestic public companies in the United States.

As we can see, this week the ratio closed at 0.03, equivalent to the value seen at the year 2000 low, in which gold bottomed at $255 per ounce. What this chart is saying is that the gold mining sector is now valued at level which previously corresponded to a major long-term bottom.

What happened after the sector bottomed at this same level in the year 2000?

A 450% rise over the next 11 years.

These Ratios Cannot Go To Zero

An important point to consider with respect to ratios between real asset classes: they cannot go to zero. Such would imply that the valuation of the gold mining sector had fallen to nil respective to the rest of the US economy. This has never happened before in history, and it never will happen.

The gold mining industry dates back to the dawn of record keeping, and will always have value within a broader measure of the civilization’s economy.

Yet at 0.03 as of this week, now is the closest to zero that this ratio has ever been.

Again, the XAU to S&P 500 ratio is now at the same valuation seen in the year 2000. It is said that history does not repeat, but it often rhymes.

Is the sector setting up for another decade-long revaluation higher again?

Gold Miners Relative To The Price Of Gold

The other critical way to value the gold miners is in relation to the very product they dig out of the ground: gold itself.

Below we show the same XAU gold mining index, now as a ratio compared to the gold price. Note that from the index inception in 1984 through 2008, the ratio varied between a range of 0.16 and 0.38, with a mean of 0.27:

Yet something anomalous happened during the stock market crash of 2008 which had never been witnessed before: the ratio between the miners and gold itself fell to 0.08 as capital for mining projects froze worldwide. The ratio made an attempt to recover into 2011, but by 2016 the XAU to gold valuation had fallen to below 0.04 – the cheapest that the gold mining sector had ever been.

Again, this ratio cannot go to zero. Such would imply that gold in the ground would be worth nothing relative to gold in coin and bar form. Yet 2016 saw the closest reading to zero that has ever been observed in the history of this relationship.

In order for the ratio to return from its present reading at 0.06 to the mean of 0.27, it would require the average gold miner to increase by 350% with no change in the current price of gold. Of course, this ratio could also revert to the mean by gold falling and the miners maintaining their present value.

The takeaway is that on a risk-to-reward basis, at this juncture the miners remain historically undervalued relative to their own primary asset. And while we believe in owning physical gold over the long run as a store of wealth, the observable data shows that in the present environment the gold miners have superior value.

Executive Summary On The Gold Mining Sector

The gold mining sector remains undervalued relative to both the broader US economy and the gold price. Ratios analysis shows the sector just barely off the lowest levels in over a generation. While both the stock market and gold itself may oscillate over the years ahead, the superior values are presently to be found in the gold mining sector.


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Christopher Aaron

Christopher Aaron began his career as an intelligence analyst for the CIA and Department of Defense. He served two tours to Afghanistan and Iraq between 2006 - 2009, conducting pattern-of-life mapping for military leaders.

Mapping shares similarities with technical analysis of the financial markets because both involve the interpretation of repeating patterns found in human nature. He is the founder of iGold Advisor, providing research on the precious metals, and iGlobal Analytics, featuring technical analysis of the global capital markets.

Christopher speaks regularly on the cyclical patterns found within the financial markets and on international policy. He has been featured in the New York Times and NPR news amongst other publications.