South African Gold Stocks: No Margin of Safety

If we're on the brink of a breakout to gold at $9,000 an ounce as UBS claims (source, Financial Times, requires registration after 2 free viewings) then let the party begin. By my own calculations, after halving my worst case scenario, gold could go as high as $9,414.16. Yeah, I know, make an outrageous claim and cement your fame. However, I have a logical explanation for my belief that a run up in gold is possible.

Confidence in my math on how gold could plausibly get to $9,000 is actually less important than the wait that we're in for to get to such a level. After all, the rise from $35 an ounce in 1969 to $800 an ounce in 1980 took a lot of twists and turns. I personally believe that we'd see a collapse in the price of gold and other related commodities before we move to the insane levels that I mentioned earlier.

There is one thing that is uniquely absent from this run up in gold that was present in 1969. South African gold stocks offering alluring dividend yields. Could you imagine getting paid 14% to invest in gold stocks that were at the early stages of a commodity bull market. In the table below, published in Richard Russell's Dow Theory Letter, you will see the South African gold stocks and the dividend yield that was paid out at that time (yellow column.)

This being a blog about dividend paying stocks, I wish I could have been around to partake in the South African gold stocks that sported such attractive yields. The downside of course was that the dividends were usually paid on an annual basis. Which was fine since Richard Russell was saying that you should be accumulating the stocks almost from the very beginning of the run up in gold in 1968 and 1969. Some of my friends, I wasn't born at the time, look back fondly to those days and always say that what they remember most about investing in gold stocks at that time was the dividends in the South African golds.

If you compare the yields on gold stocks today to the 1970's you'd think we were on different planets. As an example, Barrick Gold (ABX), a "domestic" producer, has a dividend yield of 1% while AngloGold Ashanti (AU) has a paltry yield of 0.40%. DRDGOLD (DROOY), the old Durban Deep, has the massive yield of 1.4%. In the list of gold stock provided by Richard Russell, only 3 stocks sported no dividend. None of the publicly traded South African gold producers have dividend yields that provide a margin of safety.

In an earlier posting, I scoffed at the notion of gold stocks paying a dividend just to get investors into the market. Despite that concern, it doesn't stop me from believing that if we are really in a long term bull market in commodities (inflationary period) then it would certainly be nice to get compensate for the wait.

Keep your mind open to the prospect that even if some gold stocks are paying a dividend just to get speculators in, there might be a chance that the current run up in gold is a repeat of the early stages of a genuine gold bull market. If you happen to find gold stocks with such outrageous yields then let me know, I'm always interested (only those with earnings please.)

*See my note on commodities in the comment section of my September 12, 2009 posting.

Disclosure: No positions

Comments

[Phillip Jain:]

David Einhorn of Greenlight Capital shifted his bet from GLD to bullion but either way the yield on both is 0%.

My concern is that the gold miner stocks may not pass on the full benefit of $9000 gold - the windfall profits may get "spent" by the executives. More realistically, however, the gold price may go up and down - so even if earnings are high sometimes, unpredicitability makes it hard for them to issue a steady or rising dividend.

After all nearly all miners sold out hedges to protect their mining operations precisely against this fluctuation for 2-3 decades.

Sep 14 06:08 AM

[JudeJin:]

i think the reason that the dividends are not there this time around is because the gold miners were almost detroyed during 1980 until recently. abx just lost $5 billion hedging(betting) gold futures. had abx simply didn't hedge, abx should have been paying handsome dividends in the past 3 years!

before nixon got rid of gold standard, the gold miners had been doing far better than they did during 1980-2000

Sep 14 09:11 AM

[LINDY77:]

For a yield of 14% or more on Gold stocks after Canadian Tax and exchange rate, check out "Precious Metals and Mining Trust" MMP.UN on Toronto EXchange, PMMTF on the OTC . A closed end fund, 61.33% into Gold & Silver mines, 27.68% in cash. Pays .10 CAD monthly x12 = 1.20 CAD . Take out 15% Can. Tax and multiply x .92 for Exch Rate = .9384 net US$ . I bot 3200 of PMMTF at about 6.65 USD last week = 14% + and a chance for big capital gains. Details at sentryselect.com , use MMP.UN LINDY

Sep 14 09:15 AM

[JudeJin:]

the market cap of jp morgan alone equals to all of the gold miners listed in the US combined!

try to compare this with where it was in the late 1960s, you'll definitely find the opposite answer.

there's too much margin of safety in the gold/silver miners nowadays than any time in history!

Sep 14 09:16 AM

[JS Partners:]

One caveat.....

The IMF holds $103M ounces of gold and now that they are looking to fund bailouts and raise cash there is a chance they might sell into the market which could cause a stir and perhaps a downturn in gold producers.

I doubt it would be enough to lower the dividend to SA historical prices
but I know what I am going to be buying when the IMF releases that press release!

Sep 14 09:34 AM

[ge12ar:]

Are you aware that the enitre $1.20 distribution is a return of capital and none of it represents income. Since the units are selling at a substantial premium and since you lose 15% to the Canadian gov't it seems like a very unattractive investment option to me but I appreciate your pointing it out.


On Sep 14 09:15 AM LINDY77 wrote:

> For a yield of 14% or more on Gold stocks after Canadian Tax and
> exchange rate, check out "Precious Metals and Mining Trust" MMP.UN
> on Toronto EXchange, PMMTF on the OTC . A closed end fund, 61.33%
> into Gold & Silver mines, 27.68% in cash. Pays .10 CAD monthly
> x12 = 1.20 CAD . Take out 15% Can. Tax and multiply x .92 for Exch
> Rate = .9384 net US$ . I bot 3200 of PMMTF at about 6.65 USD last
> week = 14% + and a chance for big capital gains. Details at sentryselect.com
> , use MMP.UN LINDY

Sep 14 09:54 AM

[Francis Sch...:]

One cannot compare the mismanagement of ABX with this of other Gold mine co's. Not all Goldminers hedged their Gold Production! Having said this, today's yield on goldminers is indeed a lot lower than it was in the 1980's but one should not forget that whatever is written, interest rates are low all over the world and Goldmines = Gold to be mined...and maybe the future has some surprises ready for us.


On Sep 14 09:11 AM JudeJin wrote:

> i think the reason that the dividends are not there this time around
> is because the gold miners were almost detroyed during 1980 until
> recently. abx just lost $5 billion hedging(betting) gold futures.
> had abx simply didn't hedge, abx should have been paying handsome
> dividends in the past 3 years!
>
> before nixon got rid of gold standard, the gold miners had been doing
> far better than they did during 1980-2000

Sep 14 09:55 AM

[Francis Sch...:]

If the IMF gold is really to be sold, be assured that not 'a single ounce' will see the open market...and it is not difficult to find out who's gonna take the whole lot without blinking.


On Sep 14 09:34 AM JS Partners wrote:

> One caveat.....
>
> The IMF holds $103M ounces of gold and now that they are looking
> to fund bailouts and raise cash there is a chance they might sell
> into the market which could cause a stir and perhaps a downturn in
> gold producers.
>
> I doubt it would be enough to lower the dividend to SA historical
> prices
but I know what I am going to be buying when the IMF releases
> that press release!

Sep 14 09:58 AM

[Dividend Inc:]

Greetings All,

The matter of hedging doesn't seem to answer the question of "where have all the dividends gone."

AEM and NEM have had a long standing position of not hedging their gold position. In fact, there are many gold companies that don't hedge and haven't hedged ever. By the rational used above, AEM and NEM should at least pay some kind of dividend of note. No dividend to speak of is present among the any gold stocks, either South African or non-hedging. This leaves the hedging argument out in the cold.

While I understand that the value of gold and silver mining companies is miniscule compared to say J.P. Morgan, there is the issue of compensation during the time that you wait for the industry to be recognized for its true value. This is where I'm interested in the dividend for gold and silver companies. Simply being "low priced" isn't enough to get me to throw caution to the wind.

Suffice to say, the market cap of gold and silver industry during the late 1960's was relatively small compared to the overall market cap of all stocks traded at the time. I mean, if you take any specialized industry make the argument that the market cap of the industry is smaller than Google then you'd be right every time. The matter of market cap of the gold industry has been argued since 1990 but has resulted in little evidence of the price increases.

Thanks for reading my article.

Sep 14 09:58 AM

[Francis Sch...:]

In the 1960's and 80's we used to say that "the market capitalization of gold mines was as big as Coca Cola"! [a least Coca Cola has ever since produced something better than the crap sold by JP Morgan!]


On Sep 14 09:16 AM JudeJin wrote:

> the market cap of jp morgan alone equals to all of the gold miners
> listed in the US combined!
>
> try to compare this with where it was in the late 1960s, you'll definitely
> find the opposite answer.
>
> there's too much margin of safety in the gold/silver miners nowadays
> than any time in history!
>

Sep 14 10:01 AM

[Dividend Inc:]

Sorry Lindy77,

I guess I should have said that I only wanted individual mining companies. Partnerships, Trust and the like are not as compelling to me. Thanks for the insight however.

regards,

Touc

Sep 14 10:22 AM

[bobbybutte:]

Very wise analysis.My gut feeling is that gold prices are near their highs and there are so many better companies like Altria that pays a high dividend and unlike gold which is virtually not needed,like them or not as unemployment continues high smokers will have more time to smoke

Sep 14 11:19 AM

[West Coast ...:]

WARNING(!): It is just mindboggling to me that anybody would mention the words "South African Gold Stocks" and "Dividends" in the same sentence! These are giant sitting ducks, who sink their beaks, eh billions of Rands of investor money, into the depts of the Witwatersrand, and will NEVER SEE THEM AGAIN! What kind of dividend return can possibly compensate for that risk?

For anybody with even only a peripheral knowledge of what's going on down there it should be clear that they are headed the way of Zimbabwe. Just reading about the political background, plans, and deep corruption involvement of the ANC makes me cringe. That's just a statement, no political or racial slur, and sorry of it comes across as such (no intent). The worst thing is to invest in companies that try to operate deep expensive mines with a large capital investment there (even if they can get the electrical power, that is) - they are at the "mercy" of those folks with a large poor electorate pressing them to "redistribute" the perceived wealth (and who have an addiction to line their own pockets big time).

So - my rule of thumb would be to multiply the expected dividends over the next 5 years by a "factor of safety" of 0.5 (50%), and the ones from 5-10 years into the future by 0.25 (25%), and then subtract the future value of the nationalized hole-in-the-ground (good luck banking on the value of the foreign properties). If the sum is less than what the stock is trading for, FORGET IT!

Exception is Great Basin Gold (GBG, ramping up nicely in Nevada, and the South African property will be a low-cost, low-depth mine, a geological anomaly in that country). BUT: ONLY AS A SHORT-TERM TRADE (<5 years) until they have Burnstone up & running, and with fingers crossed that nationalization does not pick up speed before. And if they are taken out before, TAKE THE MONEY AND RUN. Disclaimer: Long AUY, YAG, GRS, GBG, and MNEAF.PK

Sep 14 04:49 PM

[JudeJin:]

"While I understand that the value of gold and silver mining companies is miniscule compared to say J.P. Morgan, there is the issue of compensation during the time that you wait for the industry to be recognized for its true value. This is where I'm interested in the dividend for gold and silver companies. Simply being "low priced" isn't enough to get me to throw caution to the wind."

so i guess you do believe in the value in the gold/silver mines. but your obssessive concern with dividends prevents you from buying them right now.

i predict that they'll start to pay handsome dividends several years down the road when the gold price is much higher and their stock prices are much higher too. if you insists on seeing dividends before buying, you'll probably miss the whole show. i guess you'll insist that you'd rather miss it than violate your principles.

investing is not about principles. it is about risk and return.

currently, the upside in gold/silver mines is far outweighing the downside.

Sep 15 02:13 AM

[Dividend Inc:]

Greetings JudeJin,

As I have said in my prior commentary on gold, I bought gold and silver bullion in 1996 in anticipation of the conditions that we're experiencing right now. I don't have to worry about actually participating in rise in the commodity. I've been in it when gold was below $400 an ounce.

Additionally, on my blog I have listed many dividend paying stocks that beat out gold and silver stocks from the period of 1970 to 1980. I specifically compared quality dividend paying stocks to gold and silver stocks during a gold bull market to show that you don't need to follow the crowd and take on excessive risk in order to benefit from high inflation periods.

I'll give you an example of what I'm talking about. On a total return basis, Sysco Foods (SYY) crushed Newmont Mining (NEM) and Couer D'Alene (CDE) from the period of 1970 to 1982. 1982 being the very beginning of the bull market in stocks. From the period of 1972 to 1980, SYY matched the performance of gold and silver stocks.

There are so many stocks that fit this pattern during a gold bull market that you don't need to be in gold and silver stocks to benefit from inflationary periods (link to article at: dividendinc.blogspot.c....) Remember, gold and silver stocks are supposed to exceed by a wide margin the performance of the actual metal. Therefore, it would almost seem stunning that there are many companies that beat gold and silver stocks during the biggest gold bull market in history.

Finally, my discussion about being compensated for the wait demonstrates clarity on the matter of risk/reward. I address a matter that needs to be raised whenever considering any investment "opportunity." Not addressing this issue of compensation ignores the risk that an investor faces. While you call my focus on dividends obsessive, I call it a calculated approach. We're probably talking about the same thing...assessment of risk.

In a shameless self-promoting fashion, I ask that you please poke around my blog and review the points that I have previously made. I'm hopeful that you'll find convincing evidence on the points that I have made and maybe something of value.

Thanks for reading my article.

-Touc


On Sep 15 02:13 AM JudeJin wrote:

> "While I understand that the value of gold and silver mining companies
> is miniscule compared to say J.P. Morgan, there is the issue of compensation
> during the time that you wait for the industry to be recognized for
> its true value. This is where I'm interested in the dividend for
> gold and silver companies. Simply being "low priced" isn't enough
> to get me to throw caution to the wind."
>
> so i guess you do believe in the value in the gold/silver mines.
> but your obssessive concern with dividends prevents you from buying
> them right now.
>
> i predict that they'll start to pay handsome dividends several years
> down the road when the gold price is much higher and their stock
> prices are much higher too. if you insists on seeing dividends before
> buying, you'll probably miss the whole show. i guess you'll insist
> that you'd rather miss it than violate your principles.
>
> investing is not about principles. it is about risk and return.<br/>
>
> currently, the upside in gold/silver mines is far outweighing the
> downside.
>
>

Sep 15 10:35 AM