The behavior of gold stocks over the last few months has been nothing short of bewildering to say the very least! I don't know when the outlook for gold stocks was so strong yet they have been this cheap! Below is the estimates for EPS and Sales P/S for one of the gold mining bellwethers - Barrick Gold (ABX). It should come as absolutely no surprise that analysts have been consistently upgrading their earnings and sales estimates for Barrick.
Estimates of EPS (top) and Sales Per Share (bottom) of Barrick Gold
click to enlarge
Yet Barrick is trading on one of the cheapest P/E ratios (not to mention other valuation metrics) in its history (well at least in the lower quartile).
P/E Ratio of Barrick Gold
It seems that no matter how high gold has moved over the last 12 months there was a general disbelief that the rise in gold would be sustainable as would the earnings/cash flows generated by Barrick as a result of the soaring price of bullion. Yes, the valuation attached to the earnings of large cap gold stocks and the assets employed to generate those earnings tells you a lot about how bullish the crowd genuinely is towards gold and accordingly how crowded the "long gold trade" really is.
One can also look at the performance of gold stocks relative to the price of gold itself to get an idea as to how "popular" the gold trade is. The theory here is that when gold stocks are very popular with the investing public, valuations will be bid up so that the HUI will trade at a significant "premium" to the price of gold.
Below is the HUI index relative to the spot price of gold going way back to the start of 1995 (sorry but this is as far back as it would go). You can see from this graph that large cap gold stocks (as per the HUI Index) and the bullion price have traded around 1:1. Currently this ratio stands at 0.78 which means, here and now, gold stocks are comfortably undervalued by about 30%.
The HUI Index relative to Spot Gold Indexed to 1 on 1st Jan 1995
I would suspect that when the bull market in gold and gold stocks ends, gold stocks will be the talk of the town and the HUI will trade at at least a 40% premium to the bullion price. Granted this is a rather "rough" approach to valuing gold stocks but either which way it suggests that there is a lot more upside potential in gold stocks. Perhaps with the HUI Index breaking to a new high on Friday against a backdrop of a rather weak S&P 500, the upside is finally getting into gear.
Disclosure: I am long GDX.
