The Gold Miners Index (GDX) has seen an incredible rally off of its September 2018 lows and was up as much as 75% before the ensuing correction in September. The good news for investors in the sector is that valuations remain quite palatable despite this significant thrust higher. While most would expect the group to be expensive after out-performing nearly all other industries in the past twelve months, this is not the case at all. The recent 15% correction in the Gold Miners Index has pulled many of the gold majors down to even more appetizing levels on a valuation basis, and I would expect funds to step in as buyers if we do see any weakness from now until the end of Q1 2020. This is because both earnings and revenue estimates continue to be revised higher, and this will leave these companies even more undervalued as we enter the next year. We’ve yet to see complete confirmation the lows are in, but the reward to risk for investors in the sector is the best it’s been since May.
While some investors prefer to use P/E ratios as a way of gauging valuation in a sector, I much prefer using price to sales ratios as it’s much more challenging to manipulate. Some accounting tricks can be played with earnings by moving items around into different categories, but there is nothing a company can do to manage revenues. Outside of a non-core asset sale, which is rare, I have found the price to sales ratios to be one of the best ways to gauge valuation metrics. If we take a look at the largest gold miners and compare where they sat in the 2000’s vs. where they sit now, we can see that things are not even approaching frothy levels from a pure valuation standpoint.
Looking at the above chart, it’s evident that the prior peaks in price to sales for miners were multiples of where we sit currently. Yamana Gold (AUY) peaked at 36.0x sales in 2006, Agnico Eagle (AEM) topped at 26.6x sales in 2009, and Barrick Gold (GOLD) topped at 7.4x sales in 2006. The median peak price to sales ratio over the past fifteen years for gold majors has been 13.9x, while the average peak price to sales ratio was 18.1x. Due to significant outliers among some mid-cap names, I believe the median values are much more relevant.
If we look at current valuations on the right side of the chart, the price to sales ratio among the same five gold majors is currently sitting at 2.91x on a median basis. This is nearly 10% below the peak price to sales ratio at the 2016 highs, and this should be extremely encouraging to investors. The reason for this is that gold is not only at higher prices providing better margins for these gold majors, but gold (GLD (NYSE:GLD)) broke out this year, something it couldn’t achieve in 2016.
To summarize, the gold majors are currently trading 10% below their 2016 peak valuations despite working with better margins, and a five-year breakout in gold. If we were to return to the 2016 peak levels, we would see the Gold Miners Index return to the $30.00 level. If we were to trade 15% above 2016 price to sales peak levels, which is closer to fair value, the Gold Miners Index would head over the $32.50 level, 20% upside from here. For this reason, there is undoubtedly a case to be made to be nibbling on miners into weakness. I would expect any drop under the $26.00 level to find strong buying pressure from funds as most gold companies are likely to report record revenues in 2020.
(Disclosure: The author owns shares of Franco Nevada (TSX:FNV) and Marathon Gold (TSX:MOZ).
The VanEck Vectors Gold Miners ETF (NYSE:GDX) was trading at $27.36 per share on Thursday afternoon, up $0.55 (+2.05%). Year-to-date, GDX has gained 17.73%, versus a 12.96% rise in the benchmark S&P 500 index during the same period.
GDX (NYSE:GDX) currently has an ETF Daily News SMART Grade of C (Neutral), and is ranked #8 of 33 ETFs in the Precious Metals ETFs category.