Gold mining is a tough business. It is capital intensive to wrestle the yellow metal from the ground. Once mined, gold – the most valuable asset on the company’s balance sheet – is sold.
Sometimes miners are forced to sell their gold for less than it costs to mine. The miners' fate often depends on the price of gold.
For the novice investor, the price of gold has become unpredictable. During QE1 and QE2, gold (NYSEArca: IAU) and silver (NYSEArca: SLV) soared because investors were afraid of inflation.
During QE3 and QE4 investors were still afraid of inflation, but gold and silver tanked. Same circumstances, different outcome. Go figure. Instead the S&P 500 (SNP: ^GSPC) soared.
Most of the time the gold mining sector is not the best place if you’re looking for return of capital.
But, if you can catch a major bottom (or a gold bull market), even the gold mining sector can pay off big time.
The Market Vectors Gold Miners ETF (NYSEArca: GDX) is up 36% since its June low. Is the suffering over for the bruised mining sector?
This will largely depend on the price of gold (more below), but first let’s take a look at one unique indicator.
The chart below plots the SPDR Gold Shares (NYSEArca: GLD) against the Market Vectors Gold Miners (GDX) and the GDX:GLD ratio.
The GDX:GLD ratio basically measures the price of gold stocks compared to the price of gold. When the ratio is high, miners are expensive relative to gold. When the ratio is low, miners are cheap relative to gold.
As per this measure, gold miners are cheap now and were ‘major bottom worthy’ cheap a couple of months ago.
If you go back further - until 1996, comparing the Gold Bugs Index (NYSEArca: ^HUI) with the price of gold - you will find a lower ratio in 2001, which was when HUI bottomed.
So this particular indicator suggests that a major low for gold miners is in. But what about gold prices, the lifeblood of every mining operation? The article Is The Gold Rally Real or 'Fool's Gold?' takes a detailed look at gold prices.
Simon Maierhofer is the publisher of the Profit Radar Report.
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