Sunday, September 5, 2010

The Problem With Gold Stocks

I like to analyze stocks by looking at a company's long-term financial results - cash flow, revenue, and what not, and looking at the interplay of these things with stock price. But I have found this approach to be all but useless in picking gold stocks. The performance of gold miners has nothing to do with their current financials other than simply having enough capital to pursue their projects. You see valuation ratios all over the map during their big climbs, much more so than with any other type of stock. They defy about any monetary type of analysis that may work reasonably well on stocks in general.

So how do you analyze the miners other than projecting the price of gold? Well, you have to resort to leaning on the expert opinion from the people who know more about gold mining than you ever will. These people can be book writers, commentators, newsletter writers, or Ralph, your barber. But all these people suffer from one or both of two key shortcomings (1) they are not geologists and (2) they are not officers of the mining company. It stands to reason that these are the people who know at least as much as the most informed newsletter writer, and probably more. I wouldn't think the company's officers surrender all the key information they possess to anyone on the outside.

So how does the average Joe Investor glean guidance from these people in the know ? First, you can get a feel for how good a management is by just looking at their stock performance over the course of the gold bull market so far. If the stock persistently shows little correlation to a rising gold price over the years, you have to wonder about the market's judgment on the management's ability. If the stock is to take advantage of a future rise in gold's price, it means this company's leaders are going to have to suddenly find a lot of new gold or change their management stripes. The odds are against both. I ran across a thoughtful piece in the archives at "Industry Overview: Gold Mining & Exploration" by Derrick Irwin CFA that discusses this dilemma of gold stock analysis. His take:

We believe the most important factor to consider when evaluating an exploration company is the quality of management. In analyzing mining companies, we evaluate managements' experience in the exploration industry, and their track record for discovering gold deposits in the past. This is particularly relevant in regards to the geology team members, who will need to make important decisions regarding where to look for gold anomalies and how to proceed with drilling. On the management side, can the team attract continued investment to fund ongoing exploration activities?
But there is perhaps a more direct way of tapping the knowledge and confidence of the management of a public mining company - insider buying and ownership level. They are putting their money where their knowledge is when they make these publicly available transactions. When these people place their personal money with an individual company in an arena where individual stock performance is very shaky, it means something. Irwin's opinion:

In our view, significant insider ownership is one of the most promising indicators of a healthy exploration company. Management is close to the exploration process and clearly understands how encouraging exploration results actually are, or what the status of agreements with vendors and development partners actually is. We also view management participation in follow-on offerings as a sign of continued faith in the prospects of an exploration company. We do not look at a "threshold" level of management ownership, but we do place higher value on larger ownership percentages. Also, we look for depth of ownership among management - does the whole board and management team hold significant shares, or are the shares concentrated in the hands of a founder or one large owner? A strong board and management team with significant share ownership is one of the most positive signs that an exploration company is healthy, in our view.

With that in mind, I surveyed the miners that report insider activity (in the US anyway) and found some that currently have unusually high levels of insider held shares. Here is the top tier:

AZC Augusta Resource Corp 20%
NSU Nevsun Resources Ltd. 20%
XPL Solitario Exploration & Royalty Corp 15%
MDW Midway Gold Corp 11%
TLR Timberline Resources Corp 22%
PZG Paramount Gold & Silver Corp 34%
UXG US Gold 25%
GORO Gold Resource Corp 49%
NG NovaGold Resources Inc 32%
ANV Allied Nevada Gold 35%
RBY Rubicon Mineral Corp 21%
Midway Gold is the laggard of this group with 11%, but a whopping 64% of that insider ownership level has come about just over the last two years - a lot of recent insider buying.

How is this strong insider interest line up playing out over the past year ? Well, if you take the top 10, leaving off the low 11% of Midway, a lot of which is recent buying; and figure this portfolio's performance, you get +65% vs about +19% for the HUI gold stock index since this time last year.

The problem with gold stocks is you can't depend on our trusty valuation ratios, cash flow curves, or other normally useful parameters. Gold stock value is not about money put on past statements, its all about pulling future ore from their properties. You have to analyze the price of gold with all its complexity and danger. But most importantly, you must look inside the minds of the people who run the companies.


  1. This is an excellent review about how to invest in gold stocks. Insider positions is "perhaps" the best way to view the "potential" of a junior gold miner.
    Can you do this for the majors?

    Will see what I can find for AEM and GG as well as CSI.TO (operations in Brazil but a Canadian Firm). Thank you for the insight.

    cheers from rainy Austin Texas/Sept.7, 2010 @
    11:47 pm CST

  2. As for the majors, I was just surveying the juniors, because the very large cap stocks almost always have very low insider percents. It's difficult to buy a fat percentage of a large cap no matter who the insider is. AEM is around $10 billion cap with 0.2% insider ownership and GG is just a $736 million cap but with only 0.2% insider shares. A glaring exception to this rule is BVN - they are a $10 billion cap company with no less than 37% insider ownership!

    An excellent source to check on these figures is - just click on "ownership" in the menu at the top and enter a ticker. They just do US exchanges (none of the good Canadian stuff).

    I'm looking at this market cap vs significance of insider levels issue, and will put up a post soon.

  3. P.S. - The "ownership" tab is under "screener" at