Few investment topics have incited as much passion over as prolonged a time frame as gold, a substance need by few but desired by many for its aesthetic beauty and, I suppose, based on a gentleman’s agreement among members of the human race that makes it a primary, tangible, objective, store of value. As with anything that’s so popular, gold attracts its fair share of sketchy characters, including some who seem deeply arguably disturbed, and others who see ethics as a choice that’s at made occasionally at most -- an example of the latter being the a promoter who, it seems, used some unknown means of finding my personal e-mail address and sent me a solicitation pumping some unknown bulletin-board gold stock minutes after my 1/9/12 article, The Case for Investing in Gold, went up on Seeking Alpha. But in that earlier article, I explained why it’s also reasonable for rational investors to give the yellow metal some attention, mainly through ownership of the SPDR Gold Shares (GLD) ETF.
Those who’ve seen my articles before know that given my background in fundamental analysis and stock screening, I’m not likely to let matters rest there. And I won’t. As I did with oil a week ago, I couldn’t resist digging into mining stocks to see if this route could deliver better results. Interestingly, the answer is the same as for oil: Yes.
First off, notice that I’m referring now to mining stocks, not gold stocks specifically. When we screen or engage in pretty-much any other quantitative discipline, we necessarily work with the data provider whose information we use, which in the case of stockscreen123 (my platform of choice) is Thomson Reuters. The latter maintains an industry grouping called Gold & Silver and this is the one I use in my screen. So right off the top, I know I’m going to see some silver producers as well. Note, though, that mining companies are not as dogmatic as some might wish. Even a firm that is viewed as a gold miner or silver miner will often extract other minerals as well, some precious (e.g., palladium) and others more basic (copper, lead, zinc, etc. but not so much of it as to warrant being place in the more general Metal Mining group).
The reason to look at precious-metals mining stocks anyway, notwithstanding their lack of purity as gold plays, is similar to the reason why I looked at oil producers last week. Mining (like drilling) is a business unto itself with pros and cons much of which is based on volume and cost trends that join the price of the commodity of choice as influences on stock price performance. As with oil, the detailed analytic work can drive one crazy. In fact, it’s more so for miners. If you find yourself needing to kill some time, go to the Investor Relations section of a precious-metals miner and dive into the 10-Ks, interim reports, and PowerPoint presentations if available. See how many geological diagrams and production tables you can absorb before you give up, get into a lotus position if you can, and chant “Om.”
All of this information is important. If you’re not interested in production trends, reserve additions, property acquisitions, product yield, extraction costs, etc., then there’s no reason to look at anything beyond GLD. But if you can get even some of these other trends working in your favor, you may be able to outperform GLD, and that’s something especially worth thinking about now with gold prices not soaring at the moment, as they had in the late 2000s.
In connection with my low-priced stock newsletter, I noticed that similar operating trends among oil producing companies translated quite well to the kinds of financial fundamentals investors, particularly those who use stock screeners, use. This article is the result of a follow-up effort to determine whether operating data for mining companies also translated effectively to fundamentals, and the affirmative conclusion I reached. Again, though, and it’s important that this be understood: This is a case for mining companies that emphasize gold and silver, rather than a pure play in gold. I showed on 1/9/11 that GLD is arguably a better precious metals play than iShares Silver Trust (SLV). But when we turn our attention to the mining companies, we may find situations where operating-fundamental characteristics are such as to put more diversified, or even primarily-silver miners, over the top. In other words, silver prices alone aren’t enough to push SLV ahead of GLD, but prices combined with other business characteristics may be sufficient to justify favoring a silver miner ahead of a gold miner.
Let’s start our exploration into screening by looking at Figure 1, which compares precious metals mining stocks with the GLD ETF.
That is not impressive, not at all. But it is not surprising. Stock screening is about use of fundamental data to separate potential winners from potential losers. Figure 1 shows we really do have to get into the fundamentals. We can’t outperform GLD with a dartboard.
Figure 2 shows what happens when we bring fundamentals into the mix.
It’s not a panacea. There were periods when we’d have been better off with gold. But there were enough occasions when stock selection was so much better as to make the effort well worthwhile, in my opinion, not necessarily as a substitute for GLD, but as an enhancement.
The screen starts with the basics (limiting consideration to companies classified by the data provider as being engaged primarily in Gold & Silver Mining, stocks that trade on the NYSE, the AMEX or the NASDQ, stocks whose 60-day average daily volume is at least 15,000, and stocks priced below $10 (I love this relatively inefficient area of the market and testing showed that while this alone doesn’t produce great performance, it can magnify the favorable stock-market impact of desirable fundamental characteristics). The screen then requires that the stock’s 50-day moving average, divided by its 200-day moving average rank in the upper half relative either to all stocks or the universe as filtered by the basic rules described above. The idea of this flexible rule is to take a bit of input from Mr. Market (which allows me to benefit from qualitative factors that can’t easily be measured in a screen) without carrying this so far as to turn me into a momentum investor. Fundamentals are applied to passing stocks by ranking them on the basis of my multi-style QVGM (Quality-Value-Growth-Momentum) ranking system.
I started with the idea of choosing the top 5 stocks, and that is reflected in Figure 2 above. But the question of list size is usually an interesting one when the universe subjected to the sort is small (as of today, only 28 stocks were ranked based on QVGM). Ranking systems such as this, as with just about any quantitative protocol, are creatures of probability. How granular can we get when using a ranking system? The ideal would be for the top-ranked stock to outperform the second stock, for the second stock to outperform the third and so on all the way down to the bottom, where, in this case, stock number 27 would outperform stock number 28. Reality, however, is very different. If the average return of stocks 1 through 5 can come in above the average of stocks 6 through 10; if the latter can beat stocks 11-15; etc., that’s pretty darn good. That approach often works well when I seek to identify a Top 15 or 20 out of a much larger grouping. But when the sortable universe is not much larger than my final listings usually are, I have to take a closer look at list size.
Figure 3 expands the above presentation to also show the results of a performance backtest based not just on the top five, but also based on the top three, and based on the number-one stock taken by itself. (All tests presume four-week holding periods).
Figure 4 shows the backtest results in table format.
Generally, we confirm that buying just any precious metal miner is not the way to go, nor can we assume a simple requirement that stock be priced at or below $10 will help. But use of this particular model to choose five or even three stocks showed itself to be quite interesting. While the model won’t always outperform GLD (the 3-stock version underperformed in 2005 and the 5-stock version came up short in 2011), there have been powerful pockets of strength (such as 2006 and 2009-10) that can give the model a substantial long-term edge.
The 1-stock version is especially interesting. Given the nature of ranking systems and probabilities, this is a hard concept to embrace. But the potential is definitely interesting. This approach had its dud periods (2005 and 2010; I’m ignoring 2008 because everything was a mess back then). But when it’s been good, it’s been very, very, very good. Given my sense of probabilities, I’m not sure I’d ever want to buy only the top-ranked stock simply because of its position on the list. But if I’m using the screen as an idea-generator to launch further company-specific inquiries, I’d certainly pay extra attention to the number-one stock.
Here are the stocks that make the screen as of now.
As it turns out, today’s list is primarily a silver-oriented. Hecla Mining (HL) is the blue-chip of the group, so to speak. It was a well-established old-timer back in the early 1980s, when I briefly covered it as a junior analyst at Value Line, and its Lucky Friday mine, an old mainstay which I wrote about back then, is still going strong. But don’t be fooled by age. HL is exploring aggressively and adding to its reserves. And interestingly, the company initiated a cash dividend linked to silver prices (the yield, based on current conditions, is 1.4%). The stock hasn’t been a barnburner in this generation, given the so-so trends for silver prices and the economic impact of the financial crisis, but if you want a long-term play based on the volume story, this stock would seem nice to hold as supplement to GLD. Revett Minerals (RVM) is like a younger HL; another volume-oriented silver play.
AuRico Gold (AUQ), much of whose asset base has been in Mexico, is the list’s gold play. And like HL, it has a link to my youth. At the same time I covered HL for Value Line, I also covered a Canadian gold miner called Northgate Minerals, an outfit which I encountered again in the recent past when its solid fundamentals caused it to occasionally appear in the model I use for my low-priced stocks newsletter. On 10/26/11, AUQ acquired Northgate, a move that ought to make it a much more substantial part of the micro-cap gold universe than it has been to date. Committed gold bugs may be disappointed that there’s only one such stock on today’s run of the screen, but as small gold-mining plays go, AUQ looks to be a good one.
Nevsun Resources (NSU) and Alexco Resource Corp. (AXU) are truly speculative plays, especially NSU, which has properties in Eritrea. Both are in early stages of development. That can be a bit spooky to fundamental types like me, who prefer to see longer track records, as opposed to growth rates that look powerful because of their up-from-nothing characteristics. But as early-stage companies go, we’re not dealing with biotech or nanotech type situations. These mining companies have facilities that are now producing and generating real money, and given a stock market that can be more inclined operational newbies than I usually am, their stocks, along with RVM, have had more episodes of strength lately.
HL and AUQ (thanks mainly to the Northgate addition) are more to my old-line taste. But I can easily see where investors intrigued by micro-cap miners might be more attracted to RVM, NSU and AXU, the kids on the block. It is decisions like this that often motivate me to just buy the list as a whole (as I might do if I decide to join the mining play), which is not necessarily a consolation prize. Investors have long become habituated to company-specific stories. But I have to tell you that most of my best returns over the years have come about as a result of buying entire lists produced by carefully constructed screens, consistent with test results I usually present.