The Latest From Sprott

Wed, Sep 14, 2011 - 4:02pm

I just received this email update from Sprott Asset Management. A must read for all invested in miners.

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Gold Stocks: Ready, Set,…

By: Eric Sprott & David Baker

Last week, the HUI Gold Index marked a new all-time high as it surpassed 600. Recent gold equity investors were undoubtedly happy with this move, but for longer-term holders, the recent strength is actually somewhat disappointing. If you review the chart below, you’ll notice that while the gold price has almost doubled since early 2008, the HUI Index has appreciated by a mere 22% over the same period (see Chart A). If the HUI was justified at 500 in early ’08, it should surely be justified at 1,000 today, given the appreciation of the gold price over that time. So why have the equities lagged?

Chart A

Source: Bloomberg

First and foremost: the sell-side’s abysmal gold price estimates. Table 1 shows the average gold price that analysts are using to value gold equities today. While the futures market is comfortably forecasting a continuation of today’s levels, the majority of sell-side analysts refuse to update their gold price estimates to reflect its recent strength. A rising gold price is normally a bad sign for the broader equity markets, and generally indicates a bearish trend. As bears ourselves, we’re completely fine with this, and invest accordingly. But the sell-side has difficulty pairing bearishness with new underwriting opportunities. It doesn’t mean you have to believe their price forecasts however.

The second reason is gold’s volatility. The amount of paper gold and silver contracts that trade on the futures and equities exchanges still dwarf the amount of actual physical trading that takes place. Paper markets continue to set price discovery – thereby allowing for dramatic volatility with little or no influence from actual physical fundamentals. In the LBMA market, for example, market participants traded an average 19.6 million ounces of gold PER DAY in July 2011.1,2 Keep in mind that the total gold mine production in 2010, globally, was approximately 86.5 million ounces. Global gold mine production is not expected to increase significantly year-over-year, so the LBMA is essentially trading a year’s worth of production in less than a week. And this is just ONE market. When you add the COMEX futures and gold ETFs, the paper trading volume becomes absurdly high. When price discovery is dictated by levered paper contracts with no physical backing, it’s extremely easy and relatively inexpensive to jostle the spot price around. The result for gold has been many days of extreme downside volatility, despite a strong and consistent overall upward trend. Investors don’t like volatility – and the constant whipsawing has probably kept many of them away from the gold equity sector as a result.

Thirdly – investors still remember how badly gold equities got crushed in 2008. There was a reason they sold off so aggressively however – they were the most profitable positions investors owned going into the ‘08 crisis. Gold equities had enjoyed a strong bull trend going back to 2001, with the HUI Index appreciating by 980% from its November 2000 low through to August 2008. Investor behaviour is fairly consistent – when panic hits, you sell your winning positions first.

Something has changed recently, however. A new divergence has arisen in the precious metals equity market – a subtle, but plainly evident shift in recent daily performance. On Wednesday, August 10th, for example, the Dow dropped 4% while gold stocks rallied 3%, for a delta of 7% on the day. That is significant outperformance, and not what we have come to expect on an equity market down day. Gold stocks, as represented by the HUI Index, also seem to be breaking away from their traditional correlation with the spot gold price. On August 29th, spot gold dropped 2.16%, while the stocks fell by only 0.81%. On September 7th, gold fell by 3.09%, while gold stocks rose by 0.33%. These small differences indicate a new trend forming. While gold’s daily volatility is expected to continue, we may be entering a new phase where the stocks react less harshly on gold down days, and outperform gold on days of strength.

The gold equities’ recent divergence has played itself out even more prominently against the financials, with the HUI Index outperforming financials by a stunning 49% since the beginning of July (see Chart B). As we wrote in "The Real Banking Crisis" two months ago, there appears to be a run on European banks, and financial stocks are reflecting that. IMF Managing Director, Christine Lagarde, recently confirmed as much in her Jackson Hole speech, where she warned about the banks’ need for urgent recapitalization: "They must be strong enough to withstand the risks of sovereigns and weak growth. This is key to cutting the chains of contagion. If it is not addressed, we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis."3Investors aren’t waiting around to see if they’ll pull it off, and as the chart below suggests, at least some of them have reinvested their former bank equity capital into the precious metals sector.

Chart B

Source: Bloomberg

As a side note, Chart C symbolizes the great wealth redistribution that has taken place since 2000. Those investors who have owned precious metals equities have prospered, while those who have invested exclusively in the broader equity market or financials have little to show for it. We clearly see this trend continuing, and even accelerating, in the coming years.

In many of the funds we manage at Sprott, we’ve transitioned out of gold bullion and into gold equities to better participate in the continuation of the trend indicated above. As long-time investors in this space, we can assure you that the production growth rates will be significantly higher in the junior stocks. They continue to trade at discounted valuations, and we believe they offer the best opportunity to build exposure. Margin expansion is the key metric for this industry, and the market is now acknowledging the miners’ improvement in margin capture – which has occurred despite the increase in capital and operating costs (see Chart D). We meet with a large number of gold mining management teams on a weekly basis, and based on those meetings, it appears that the average cost of producing an ounce of gold today, all in, is now around $800. At $1,200 gold, these companies can capture roughly $400 in EBITDA. At $1800 gold, however, they’re now capturing $1,000 per ounce in EBITDA - representing an increase of 150% in profit margin. That is significantly far above what any other equity sector has been able to generate over the past year.

Amazingly – despite this new reality for gold producers, we are still finding opportunities in select gold and silver mining companies that can be purchased today at 2-3 times their 2-year-out forecasted cash flow. These multiples are based on the current gold and silver spot price, and if these companies hit their production targets, and gold and silver continue their appreciation – we may discover that these stocks were trading at less than 1 times 2-year-out cash flow today. Having been in the business for many years, we can tell you that investing in a stock at 1 times 2-year-out cash flow tends to be a winning proposition – let alone in an industry that literally mines the world’s reserve currency out of the ground. 

Chart C

Source: Bloomberg

Chart D

Source: BMO Capital Markets

In our view, gold stocks represent a bona fide growth sector in an otherwise dreadful equity market. All other equity sectors are weakening due to sovereign uncertainty and the reemergence of soundly weak economic data. The recent disconnect between gold equities and bullion isn’t new either. We’ve seen it before over the past decade, and the returns generated after previous divergences have averaged around 26% (see Table 2). Given the recent performance correlations, the HUI’s breakout above 600 and spot gold now firmly above $1600, we expect this rebound in gold equities to be prolonged and much more significant in percentage terms.

Equity investors shouldn’t let 00 gold dissuade them from participating in precious metals equities. The world is still dramatically underexposed to gold, and we firmly believe it should represent a higher percentage of investors’ total portfolios today. The fact remains that both gold and silver continue to trade well below their inflation-adjusted highs in nominal terms, and the market is now beginning to acknowledge the profit potential that precious metals equities offer at today’s bullion prices. We believe the equities will offer more upside than the bullion over time. Many of the smaller names are well priced and have momentum behind them. The prospects for gold stocks look extremely bright. 

For more information about Sprott Asset Management’s investment insights and award-winning investment capabilities, please visit

About the Author

turd [at] tfmetalsreport [dot] com ()


Sep 14, 2011 - 4:07pm


You posted in a thread or so ago - lots of new ones today! - that the market prices were incongruent with crude down and heating oil up. We need to fill our tank before the winter and we're trying to work out today what the price of heating oil is based on - is it WTI Crude or Brent Crude as they are behaving so differently that which ever one is correct will influence whether to buy now or hold on. Do you know, or anyone else, which one it is?



Sep 14, 2011 - 4:07pm

Not digging this close at

Not digging this close at all.

( Must walk away )

Sep 14, 2011 - 4:07pm



Edited to add: Yes indeedy!!

Sep 14, 2011 - 4:17pm

The American Debt Crisis

Was lucky enough to be invited to watch the free live video conference today of the Senior Casey Research team entitled 'The American Debt Crisis' (for Casey Gold Report subscribers which I am, I guess) with guest speakers of Lew Rockwell, Mike Maloney & John Mauldin. Very good and everything lined up with Turds & fellow Turdite thinking.

Investment recommendations were:

Physical gold and silver (in your ownership, not ETF)

Junior explorer stocks


& Biotech stocks. Does anyone of the knowledgeable Turdville community know much about Biotech stocks and start ups/companies and could offer an opinion? Couldn't see a Biotech forum (unless I missed it) & if there is, could you point me in the right direction as I know that the main comment thread is probably not the place to get into this discussion. If there isn't would it be worth starting one so that those who are 'in the know' could share their thoughts?



Sep 14, 2011 - 4:20pm

Repost due to contest confusion

Submitted by benroberts13 on September 14, 2011 - 3:31pm.

No Turd, you have not made any errors in judgment. You cannot possibly time and prognosticate these markets with absolute perfection. I know you want to, and when things are not in such dire straits and turmoil, perhaps your score is much better. Look at the nonsense manipulation going on today.

1. Dollar down

2. Crude down.

3. Dow up 226 points. Nasdaq up. S&P up.

4. Platinum up

5. Heating oil up

6. Gold down and silver down.

All of this is totally counter-intuitive and totally insane. Does not make a bit of sense. Who in their right mind buys this total B.S.?

Yes, I know the markets are manipulated in the extreme. I know they are mashing the Pm's with a vengeance for two whole weeks now. But who are these idiots that follow like lemmings to their own slaughter? Cuz, this ain't all EE buying those stocks. There are a lot of brain dead mind controlled idiots buying up this crap. When in hell are these fools going to wake up?? I get so tired of this nonsense. It's as if the whole world has gone totally nuts and everyone is doing the wrong thing. Today’s market action is proof positive that mental illness is rampant.

You Turd, just keep doing what you have been doing so extremely well. I don't know anyone better at this than you. Short term daily market analysis is extremely difficult and you are the best. No one even comes close or dares to even try. Don't let anyone discourage you in the least.

At the very least, your daily updates and projections are an encouragement and inspiration to us all. Only idiots think you should always be flawlessly correct every day. Keep up the good work my friend, and yes, step out on a limb. We will be there to catch you when you fall.

Dark Matter
Sep 14, 2011 - 4:23pm

If it were that easy

If it were that easy to identify the good silver and gold juniors.

Just look at Silvercorp!

Dark Matterbensgone
Sep 14, 2011 - 4:28pm

Triple witching hour

You are aware that triple witching hour (actually, quadruple witching hour) is approaching? Next Friday...

Sep 14, 2011 - 4:29pm

rasputin and biotech

to rasputin -

What about biotech do you want to know?

Big pharma is hitting biotech. The takeover targets are hard to discern because the politics which is infecting the financial services industry is also impacting the financing of the M&A.

If you focus on fundamentals in biotech, you could still be wrong in the stock play.

This is why I prefer to focus on precious metals.

Sep 14, 2011 - 4:31pm

Interesting comments in response to Zero Hedge article:

Credit Is From Mars, Stocks Are From Venus, Or Another Reason Why This Market Looks Increasingly Like 2008

Cdad This is how the big boys play in the New Normal market. They run prices up and get the algos chasing. They let the dumb algos take the last leg, which the big boys sell into. You can see it now, the block selling.

The secondary benefit is that, now that the algos have marked stocks to "stupid", the institutions have the green light to bear raid without much fear of the market snapping back on them.

Oh...and also...prices don't mean anything anymore. The computer Pachinko machine market can price things anywhere...and then change them in seconds. And you won't know what happened until you see the roll up quotes in the after hours, when it will be revealed that massive selling was going on...but most folks could not see it as it was perpetrated through an alternative exchange.

These last two hours...entirely for the sucker fish.

vote_libertaria... In Michael Lewis's book about the 2008 crisis he mentions interviewing hedge fund managers and how they could not understand what was going on. The worst the news got the more aggressive the buying was. They found out later it was a combination of hedge fund managers doubling down to catch up and quants chasing momo. Looks like the same thing to me again.

firstdivision We have had a 42+ handle move in the past 3 days based on nothing but headline algos. This disconnect between FICC and equities is idiotic. This smells as a coordinated effort by the Banks and HF community to drive up the price and then leave investors holding the flaming bag of dog shit.

chunga Meanwhile...DJIA up 200. Makes more sense trying to predict the gyrations of a Lava Lamp.

jbc77 Sometimes Zerohedge can read my mind. I'm looking at the ramp in the markets today and asking myself how this could be happening when a systemic crisis has infected European banks. Are we chalking this up to a broken market or what? Another day in the Twilight Zone.

nobusiness Searching for sanity in an insane world

Belarus BTW, I think gold and silver is also showing this is like fall of '08. If Europeans are running from banks, they are also running from brokerage accounts, which means GLD and SLV get go buy, ahem, Gold and Silver. It really is two markets in Gold and Silver.

TruthInSunshine Who needs QE3 or QE30 when a bankrupt beggar thy neighbor G-Pap can jawbone markets (the only thing that matters, as the world burns down around them, in Bernank's Virtuous Circle Theorem) 3% higher by speaking bullshit?

economessed Folks, it's not a market. It's where dumb money goes to die. Q.E.D.

Sep 14, 2011 - 4:32pm

PLEASE carefully read Sprott

He has given you in a well written piece just a very telling summary of several important changes that have (not so subtly) occurred with the miners over the past several weeks. These are key tells and the PTB are still painting the tape to confuse the traders but the past several weeks told me everything. Miners are going to have a monster move. Don't overtrade (as I do) hold this time and only trade the margins. gl

Key Economic Events Week of 10/14

10/15 8:30 ET Empire State Fed MI
10/16 8:30 ET Retail Sales
10/16 10:00 ET Business Inventories
10/17 8:30 ET Housing Starts and Bldg Perms
10/17 8:30 ET Philly Fed MI
10/17 9:15 ET Cap Ute and Ind Prod
10/18 10:00 ET LEIII
10/18 Speeches from Goons Kaplan, George and Chlamydia

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Key Economic Events Week of 10/14

10/15 8:30 ET Empire State Fed MI
10/16 8:30 ET Retail Sales
10/16 10:00 ET Business Inventories
10/17 8:30 ET Housing Starts and Bldg Perms
10/17 8:30 ET Philly Fed MI
10/17 9:15 ET Cap Ute and Ind Prod
10/18 10:00 ET LEIII
10/18 Speeches from Goons Kaplan, George and Chlamydia

Key Economic Events Week of 10/7

10/8 8:30 ET Producer Price Index
10/9 10:00 ET Job Openings
10/9 10:00 ET Wholesale Inventories
10/9 2:00 ET September FOMC minutes
10/10 8:30 ET Consumer Price Index
10/11 10:00 ET Consumer Sentiment

Key Economic Events Week of 9/30

9/30 9:45 ET Chicago PMI
10/1 9:45 ET Markit Manu PMI
10/1 10:00 ET ISM Manu PMI
10/1 10:00 ET Construction Spending
10/2 China Golden Week Begins
10/2 8:15 ET ADP jobs report
10/3 9:45 ET Markit Service PMI
10/3 10:00 ET ISM Service PMI
10/3 10:00 ET Factory Orders
10/4 8:30 ET BLSBS
10/4 8:30 ET US Trade Deficit

Key Economic Events Week of 9/23

9/23 9:45 ET Markit flash PMIs
9/24 10:00 ET Consumer Confidence
9/26 8:30 ET Q2 GDP third guess
9/27 8:30 ET Durable Goods
9/27 8:30 ET Pers Inc and Cons Spend
9/27 8:30 ET Core Inflation

Key Economic Events Week of 9/16

9/17 9:15 ET Cap Ute & Ind Prod
9/18 8:30 ET Housing Starts & Bldg Perm.
9/18 2:00 ET Fedlines
9/18 2:30 ET CGP presser
9/19 8:30 ET Philly Fed
9/19 10:00 ET Existing Home Sales

Key Economic Events Week of 9/9

9/10 10:00 ET Job openings
9/11 8:30 ET PPI
9/11 10:00 ET Wholesale Inv.
9/12 8:30 ET CPI
9/13 8:30 ET Retail Sales
9/13 10:00 ET Consumer Sentiment
9/13 10:00 ET Business Inv.

Key Economic Events Week of 9/3

9/3 9:45 ET Markit Manu PMI
9/3 10:00 ET ISM Manu PMI
9/3 10:00 ET Construction Spending
9/4 8:30 ET Foreign Trade Deficit
9/5 9:45 ET Markit Svc PMI
9/5 10:00 ET ISM Svc PMI
9/5 10:00 ET Factory Orders
9/6 8:30 ET BLSBS

Key Economic Events Week of 8/26

8/26 8:30 ET Durable Goods
8/27 9:00 ET Case-Shiller Home Price Idx
8/27 10:00 ET Consumer Confidence
8/29 8:30 ET Q2 GDP 2nd guess
8/29 8:30 ET Advance Trade in Goods
8/30 8:30 ET Pers. Inc. and Cons. Spend.
8/30 8:30 ET Core Inflation
8/30 9:45 ET Chicago PMI

Key Economic Events Week of 8/19

8/21 10:00 ET Existing home sales
8/21 2:00 ET July FOMC minutes
8/22 9:45 ET Markit Manu and Svc PMIs
8/22 Jackson Holedown begins
8/23 10:00 ET Chief Goon Powell speaks

Key Economic Events Week of 8/12

8/13 8:30 ET Consumer Price Index
8/14 8:30 ET Retail Sales
8/14 8:30 ET Productivity & Labor Costs
8/14 8:30 ET Philly Fed
8/14 9:15 ET Ind Prod and Cap Ute
8/14 10:00 ET Business Inventories
8/15 8:30 ET Housing Starts & Bldg Permits

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