Have Gold and Silver Stocks Peaked?

February 4, 2009

Recently a handful of US based financial analysts have made a big fuss over the many secondary equity offerings of many major mining companies, stating that is a sure sign that prices of gold and silver stocks have peaked and will soon come crashing down. The reason for these dire predictions? These analysts claim that the executives of these companies are taking advantage of an opportunity to raise capital when their stocks, in their words, have absolutely peaked. Furthermore, they state that recent stories of gold jewelry sales in Abu Dhabi sliding 70% and gold imports dropping in India from 18 tonnes in January 2008 to just 1.2 tonnes in January 2009 are further proof of gold’s imminent demise. In the past couple months alone, some of the big names in the mining industry that announced plans for a secondary offering included Newmont Mining (NYSE: NEM; $1.2 billion in stock and convertible debt), Silver Wheaton (NYSE: SLW; $250 million), and Redback Mining TO: RBI – $150 million). There’s only one problem with these tunnel-visioned analysts — they’re wrong.

Yes, my analysis of numbers in the COMEX futures markets for gold and silver leads me to believe that a short-term correction in gold and silver prices and their associated stocks is probable, though COMEX numbers have to be monitored weekly to understand if short-term behavior in gold and silver markets is likely to reverse. Still, given the strong up leg that quality mining stocks have experienced in the past two months, with many tacking on gains of 100%+ in a very condensed period of time, a correction now in stock prices if it happens would be nothing out of the ordinary. Consequently, the analysts that predict the death of mining stocks use a probable setup to predict likely short-term behavior to support an ill-conceived conclusion. For example, many gold doomsayers that predicted the death of gold at the end of 2007 as we entered 2008 wrote “I told you so” articles when gold spot prices dropped below $700 in October, 2008 and used that fall to predict imminent further plunges to the $250-$300 an ounce level. When gold instead reversed from $680 to above $800, then to $900 an ounce, these analysts all but disappeared with the exception of those that jumped back on the bandwagon. However, any short-term correction that may manifest itself will be just that, a short-term correction in a fundamentally strong and intact gold and silver bull market.

The problem across the board with these “analysts” is the fact that (1) they have no understanding of the fact that the impetus for this global crisis is a monetary crisis; and (2) they evidently have very little experience, most likely 2-3 years or less, in dealing with gold and silver markets; consequently, they understand nothing about the typical volatility of these markets and the intervention of the Federal Reserve into such markets, and how to interpret this volatility and intervention. Let’s look at what’s wrong with their above analysis. To begin, one can easily discount the 70% drops in the sale of gold jewelry in Abu Dhabi because luxury goods always suffer during times of severe economic malaise. The market for gold jewelry is a totally distinct market from gold bullion or gold coins. The typical markup for gold jewelry is 300% to 400% of its melt value. Thus, nobody that is interested in buying gold as a store of value would ever buy jewelry to fulfill this purpose. Jewelry is truly a luxury item, not an investment or a store of money. The drop in jewelry sales, though severe, is not only meaningless, but would be expected by anyone that understands the gold market and offers no “proof” that the gold bull is about to collapse.

Furthermore, increases in global gold and silver ETF inventories are reported seemingly every month. There is a huge number of what I term as “lazy” gold and silver investors that buy paper gold and paper silver and use gold and silver ETFs as a proxy for the real thing. I term the investors that buy the gold and silver ETFs as lazy because personally, I would never choose to own paper representations of silver and gold for any physical gold and silver that I desire. However, if you look at these numbers, certainly nothing is wrong with the gold and silver bull. According to the most recent figures, the US based GLD ETF added another 320,000 ounces to reach 10 tonnes, the US based SLV ETF grew to a record level of 7,063 tonnes of silver, the Swiss-based gold ETF added 364,100 ounces, and the Swiss-based silver ETF supposedly 5,776,000 ounces. Whether you trust these ETFs to have the physical gold and silver in their vaults that is represented by the shares purchased is up to you.

As my final point of contention with those analysts that claim mining stocks have reached a multi-year peak now and are set for a huge decline, let’s look at their assertions about secondary equity offerings being a sure sign that mining company CEOs have recognized that their stock prices have peaked. Number one, remember that last year, many large banks tried to raise capital for day to day operations with secondary equity offerings and failed because there no market every materialized for their secondary offerings. The fact that mining companies are cumulatively raising billions of capital in such a tight credit environment is not worrisome to me, but very impressive. Secondly, the CEOs of mining companies have stated that their reasons for raising capital through secondary offerings are threefold. One, to fund acquisitions of more producing mines; two, to expand and hasten the pace of development of existing mines; and three, to increase production during a time when price inputs for production have drastically declined. Secondary offerings of equity almost always have dilutive effects on existing shares of equity in the short-term. If the CEOs of these companies also believed that this was a top for their industry, growth expansion would be the furthest thing on their minds.

It is often stated that a slick analyst can use and distort any statistic to arrive to the conclusion he or she so desires. In the end, with the proper perspective, all numbers that are used by analysts to conclude that the gold and silver bull markets are dead can be proven to have very weak legs. (Disclosure: Author owns SLW, but does not own NEM or RBI.TO)

[tags]SLW, NEM, RBI.TO, gold, silver[/tags]

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