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Is The Canary In The Gold Mine Coming To Life Again?

Acting Man
Research analyst, dividend investing, ETF investing, long/short equity

By Pater Tenebrarum

A Chirp from the Deep-Level Mines

Back in late 2015 and early 2016, we wrote about a leading indicator for gold stocks, namely the sub-sector of marginal - and hence highly leveraged to the gold price - South African gold stocks. Our example du jour at the time was Harmony Gold (NYSE:HMY) (see "Marginal Producer Takes Off" and "The Canary in the Gold Mine" for the details).

Mining engineer equipped with bio-sensor

Photo credit: Hulton Archive

As we write these words, the HUI Index is well off its intraday highs, apparently in response to the broader stock market attempting to recover. In other words, another short-term pullback in the gold sector could easily be in the cards. But something is cooking in South African gold stocks, that much is absolutely certain. Here is a chart of the JSE Gold Index in ZAR (South African rand) terms:

South African gold mining stocks break out with authority.

We actually mentioned an earlier breakout attempt in these pages that ended up getting rejected the very next day, after Gold Fields (NYSE:GFI) reported earnings the market didn't like at all. In particular, the company had to admit that it was still failing in its efforts to make the South Deep mine (its largest asset by far) profitable. The index promptly nose-dived to a new interim low. This time, we decided to wait until after the breakout to avoid jinxing it again.

After the GFI-induced shellacking, the index gradually recovered and has in the meantime broken above two resistance levels post-haste, in a quite stunning short-term rally. Gold stocks were by far the best performers on the JSE, both on Thursday last week and today (Monday). HMY, for example, tacked on almost 19% on Thursday and another 10.6% today - in ZAR terms, of course.

The JSE Gold Index is following the lead of the JSE Platinum Index, which had already broken out ahead of it in September, as no negative surprises were reported by its major constituents. To be sure, there were a few bad earnings reports in the platinum sector, but nothing unexpected occurred. In fact, after posting a huge headline loss due to taking large write-offs and announcing a major restructuring of its flagship Rustenburg mine, the stock of Impala Platinum (OTCQX:IMPUY) rallied quite strongly. Here is a chart of the platinum index:

JSE Platinum Mining Index. Another noteworthy breakout over an initial resistance area.

While we cannot be sure why investors have suddenly become enamored with the precious metals sector, it is probably a good guess that gold stocks are by now so cheap that they are considered a worthwhile target for rotation purposes. As an aside, South African gold mining stocks are, of course, rallying in USD terms as well, but there remains a lot more overhead resistance they need to overcome, as their advance was partly driven by weakness in the South African currency.

More Ground to Cover

Below are two examples, namely HMY and Sibanye-Stillwater (NYSE:SBGL). Both are well off their lows (and slightly overbought by now), but have yet to reach new highs for the year. A lot of ground will have to be covered to get to that point, particularly in the case of SBGL. HMY is actually not that far from its April peak in USD terms.

As an aside, Harmony has reported excellent earnings for several quarters in a row, but we suspect the stock was held back because the company bought a large mine from AngloGold Ashanti (NYSE:AU) earlier this year and had to fund around 50% of the purchase by issuing new shares. We would note that it bought an excellent asset at a very low price (in other jurisdictions it would have paid a lot more) and managed to retain a quite pristine balance sheet in the process.

HMY - a spirited rally in USD terms as well since hitting an abysmal low in August.

SBGL was also beset by a number of company-specific problems this year, partly related to its takeover of platinum miner Lonmin, but it seems the company is getting a grip on them.

Conclusion

South African precious metals stocks look a tad overbought in the short term, but one has to keep in mind that they have a well-established historical tendency to both decline and rally very strongly and quickly. When these stocks are particularly strong, it is often a positive medium-term signal for the sector as a whole, the potential for short-term volatility notwithstanding.

Hi there, bio-sensor! Get out your prayer beads!

Photo credit: Mirrorpix

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