Tuesday, 15 May 2012

The slump in precious metal miners

Havoc during the financial crisis 

Before the 2008 financial crisis and as late as March 08, when gold peaked above $1000 for the first time ever, the popular HUI index of unhedged gold miners quoted above 500. The ratio HUI/Gold had been in a trading range between 0.4 and 0.6 for several years. This seemed to be a dynamic equilibrium. Forced liquidations during the financial crisis caused a near 30% retreat for gold, bringing the price down to around $725 (not counting intraday lows). This meant carnage for the gold miners, which fell off a cliff, with the HUI plunging from 515 (March 14) to 152 (Oct 27). The HUI/Gold ratio plunged from 0.51 to 0.21 between those two dates.
On the graph below, HUI (blue on the left axis) and HUI/Gold (green on the right axis) are plotted during that particular period. 
HUI (blue on the left axis) and HUI/Gold (green on the right axis). The slide towards the 2008 financial crisis and the subsequent recovery during 2009.
The graph clearly indicates that the panic levels of HUI/Gold below 0.25 are in fact a few stretches of time, totalling only 11 trading days. Today we are back at this 0.25 HUI/Gold panic level, however with gold quoting over twice the October 2008 low: a slow moving train wreck.

A slow moving train wreck 

In the aftermath of the financial crisis, the HUI recovery has been swift and also the HUI/Gold ratio was up 50% back above 0.32 by mid December 2008. Through gold rallies and pull-backs the HUI/Gold ratio kept on recovering, albeit at a slower pace. General expectation was that we would be back up in the pre-crisis trading range in little time. However, the above graph breaks off at what was ultimately going to be a post-2008 maximum for HUI/Gold.
HUI / Gold ratio over the last two years, weekly observations. The blue line is a 50 week moving average, the red one is a 200 week moving average. The ratio is in a trading range until early 2011. The decline started over a year ago.
Going forward, the HUI/Gold ratio levels off in a 0.37 – 0.43 trading range. It stalls in early spring 2011 and gradually slides towards a temporary support around 0.31-0.32 which upholds during 2011. The initial slide coincides with stock markets weakening from May till October 2011. The August gold rally has not provided much support as it coincided with stock markets selling off. Late 2011 stock markets start rallying, but precious metals were drifting lower. HUI/Gold was then hovering along its support.
That support is broken early 2012 and the January – February gold recovery rally only postpones the inevitable. Early March the 0.30 support is broken on the HUI/Gold ratio and the slide aggravates. By now it costs only a quarter of an ounce of gold to buy the HUI index. Unlike during the Oct 2008 panic sales, where HUI/Gold only briefly spiked down below 0.25, the present slump has a more permanent nature.

HUI/gold - daily observations over 6 months. The blue and red lines now are 50 days and 200 days moving averages. The ratio breaks its 0.31 support in Jan - Feb but upholds more or less during the gold recovery rally.
Major gold mines are now priced for gold at $975/oz, using the post 2008 trading range (HUI/Gold = 0.40) as a reference. With the pre-2008 more favourable HUI/Gold = 0.50 that would be gold at $780. We are living in epic times.
Yet, gold mining majors being dirt cheap does not necessarily imply that the worst is over. If a collapse were to come on financial markets, margin calls would be all around. With buyers on strike forced selling in an empty market may fill whatever bid. If a stock market crisis is looming behind the corner, the major drawback over 2008 is that miners are valued at only half their early 2008 level relative to gold. A panic spike down would now yield an even more grotesque distortion of valuation than what was around in October 2008.

Most likely, the lows are near as soon as executives start buying large chunks of shares of their mining companies.

Note: The above graph with daily observations is updated on a regular basis on the blogpage: http://gwyde.blogspot.com/p/gold-miner-pulse.html

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