I analyze macroeconomic issues from a fundamental perspective, and I analyze market behavior from a technical perspective. Original macroeconomic analysis can be found here and both macro analysis and commentary can be found on my Caps blog. If you like or appreciate my analysis, please add yourself to my Following List

Wednesday, December 30, 2009

Gold Miner Performance: A Look At Miner Cost Inputs vs. Gold Price

Many of us who are bullish on gold and gold miners often talk about the Gold / Oil Ratio (GOR). The reason why this is of interest is that metal mining is a very energy intensive endeavor and the price of oil is the biggest cost input for GSMs. But just because the price of oil is high or low does not determine profitability. If the price of oil is high but the price of gold is higher (on a relative basis) then miners can still be profitable.

In order to determine profitability for a gold miner, as an individual company, you must look at the "All-In" Extraction costs: Energy inputs (are they hedged or not, what is the value of the energy hedges), ore grades in the mines, metal by-products, environmental costs, mine types and ore transportation, etc, all vs the price of gold (do they have gold hedges in place? What are some likely targets for gold prices?).

But stepping back and looking at the big picture, I want to show the impact of the biggest factor (energy prices) and how the Gold / Oil Ratio and the price of Gold affect the performance of Gold Miners as a sector. I will be using the HUI for this study since the HUI is a basket of unhedged (no gold hedges) GSMs.

Since 2000 gold has been in a strong bull market. The HUI has also been in a strong bull market, but has seen a lot more "stair-stepping" in its performance. And you can see from the chart above, that its consolidation periods coincide with unfavorable trends in the Gold / Oil Ratio.

If you are bullish on Gold and you are bullish on Gold Miners, the question you need to ask yourself is: Will Gold outperform Oil in the future (near term and long term) and during the next phase of the credit crisis (assuming we have one)?

My own opinion is that: Yes, I think the price of Oil will rise. Yes, I think the price of Gold will rise. Yes, I think Gold will Outperform Oil. Yes, I think there will be another phase of the credit crisis. Yes, I think the correlation between the HUI and the stock market as a whole will diverge, as the HUI will represent a sector whose bottom lines are increasing and the SPX (for example) will not.

But I am not trying to convince you of this. I am simply showing you a useful evaluation tool at the macro level, so that you can make sense of the behavior of a very important equity sector. The conclusions you reach for yourself are up to you.
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