More Upside For Gold Or Gold Miners?

| About: VanEck Vectors (GDX)

By Dan Simon

  • Gold has a 5 year return of 137%.
  • Gold Mining shares have traded sideways.

We have seen the price for physical gold increase for eleven straight years. It was $273 at the beginning of 2000 and it is currently trading in the $1,600 range. This is almost a 500% increase since the start of this bull market in gold. However, during the same period the mining index has only increased about 214%.

Since the 2008 credit crisis, gold mining shares have greatly underperformed relative to the product they produce. Gold peaked at $1,002 in March 2008 before the US entered the credit crisis. Since then gold has increased about 65%, while the mining shares are down 14%. Why is there such a discrepancy between the producer and the product?

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Comparing the Producer to the Product
One method for gauging the market's sentiment for gold mining shares is by comparing an index of mining shares to the price of gold. The lower this ratio gets, the more undervalued the miners are relative to the physical metal. This ratio is currently at historic lows. On a historic basis, the mining stocks have never been so cheap relative to the product they produce. Even if you expect gold to trade sideways for the near future, one could expect the mining shares to eventually catch up to its historic ratio. The gold mining shares would have to double from their current levels just to equal the performance of gold since the 2008 downturn.

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Stocks are Trading at a Discount

Another method for determining if a mining company is expensive or cheap is by its market capitalization (market cap = share price X # shares outstanding) to its Net Asset Value (NAV). The NAV of a mining company is calculated by taking the future cash flows (discounting for time, geological, political, social and financial risks) adding any other assets and subtracting liabilities. When the market cap of a company is less than its NAV it is said to be trading at a discount. In the chart below you can see that mining companies are trading at the biggest discount we have seen in recent history.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.