Any person alive in the 1970s remembers the incredible bull market in mining stocks. Toward the end of that decade, there were many stocks that appreciated 10 or 20 TIMES in just a few years from 1978 to 1980. At least one of the better-known gold stock mutual funds from that period, the Van Eck International Gold Fund returned over 22% for the entire decade of the 1970s (see Bob Kargenian, Advisor Perspectives on Investing With Inflation). Going further back in time, to the Great Depression, there were three, large gold stocks that also made people money during a time when most stock investors lost their shirts. Homestake Mining, Alaska Juneau Gold Mining Company, and Dome Mines Limited, all had average returns of about 300% from 1929 to 1933, and this does not include dividends which were often north of 8%. The prices of Homestake and Alaska have been tracked by Mark Lundeen, with the help of Barron’s Magazine, as part of the Barron’s Gold Mining Index. Lundeen has shown that these two companies generated returns of over 100 TIMES for an investor who held them from the 1930s to 1980.
Mining Stocks Suffer From Irrational Pessimism
However, Lundeen and Barron's were unable to come up with more data regarding all of the other, smaller mining companies that existed during this period. These men aren’t alone: no major financial media publication or research institute that I know of has undertaken a serious study of the performance of all gold and silver mining stocks during the first part of the last bull market in silver, from the 1930s through to the early 1970s. This, more than anything else, may be an indicator of how kooky and weird the larger investment world feels investing in gold and silver miners is. (Most major mining indexes, like the XAU or HUI were put together in the 1980s or 1990s.) Still, anecdotal evidence shows that a diversified basket of large producers with some “juniors” in them easily produced returns in excess of 500 to 1000%, including dividends. Many South African miners actually paid out dividends at different points as high as 15% (if not higher.) Doug Casey, along with his associate Jeff Clark have published some of this data, and Doug included examples of major profits in the mining sector in his book, Crisis Investing, which was a national best-seller in the early 1980s.
Like the Tide, Irrational Exuberance Will Come In With Miners
What contributed to the mining stock mania of the late 1970s was the belief that earnings growth (coupled with the price of bullion) could only go one way: up. And not just up, but up big, as in annualized rates of north of 50%. If you know anything about Wall Street, you understand that speculators and institutional money alike often demonstrate a willingness to “pay up” for growth. You certainly saw this is in the dot com bubble, where many stocks had price to earnings ratios in the 1000s—or, worse yet, did not even have price to earnings ratios because they had no earnings. But the belief was that everyone “had” to own these companies, which were hot and seemed to be a part of the best new thing to come along (the internet) since the invention of the wheel. (Understand that most companies don’t have price to earnings ratios much higher than 10 or 15, and some would even call that expensive.)
But if the mood strikes Wall Street or other assorted speculators right, the same could happen to gold and silver miners as happened to the internet stocks of the 90s, or the mining shares of 1978-1980. Valuation is subjective, and it often does not matter. Of course, this has yet to be the case, at least in the aggregate. Most of the major indexes which follow the precious metal miners have failed to keep up with the appreciation in gold and silver since 2008. Anecdotally of course, this also happened in the last bull market from 1930 to 1980. A lot of the big gains were concentrated at certain times. It was either feast of famine with the mining stocks.
Some will also point out that the other reason the mining stocks have not performed as well has to do with the fact that there are so many more ways to gain exposure to gold and silver now through a brokerage account. In the 1970s, only the Central Fund of Canada existed (to my knowledge) as a kind of bullion equity that could be held in a brokerage account. Now there are several such funds.
Five Reasons For Owning Gold and Silver Stocks
Reason Number 1:
Mining stocks can pay dividends. They aren’t back to 16%, but dividend payouts from mining stocks do appear to be growing. Recently, Newmont Mining essentially guaranteed increases in its dividend with the price of gold, as of the fall of 2011. As is often said about bullion to discredit it as an investment, bullion pays no income. Not so with mining stocks.
Reason Number 2:
Mining companies can be takeover targets and you might benefit from the bidding war for assets. I should also add that with a mining stock you own gold or silver “in the ground,” meaning a potential windfall if the next version of the California or Nevada gold or silver rush materializes.
Reason Number 3:
It is important to remember that if you own gold or silver outright in the United States, you will likely face a higher tax upon sale than owning it in equity form (either through one of the trusts like the Central Fund, or by owning a mining stock.)
Reason Number 4:
No one ever confiscated a mining stock. In the bull market from 1930 to 1980, Americans could not legally own silver bullion until the mid-1960s, and gold bullion not until 1975. Along with rare coins and jewelry, another way to hedge yourself against inflation was with mining stocks. So mining stocks are an important way to diversify yourself against the political risk that your bullion will either be confiscated or taxed at a very high rate.
Reason Number 5:
Finally, mining stocks do provide leverage to the gold or silver price, assuming that they can get their costs under control (or at least have their costs increase more slowly than the increase in the price of bullion.) For example, if a mine has a profit of 300 dollars and the price of gold moves from 1700 to 2000, it is possible that most of that 300 dollars goes to the bottom line (remember I said most, and remember this is a theoretical discussion). A 300 dollar increase in the bullion price was only about a 20 percent increase, but a 300 dollar increase to the bottom line of the mining company is a 100% increase! Hopefully you can see the difference.
However, all of this is dependent upon Wall Street recognizing this story, and deciding that it wants to in fact pay up for this kind of earnings growth. The mining stocks are just not well understood at the moment, and frankly, they suffer from the fact that leverage can work in two ways. In the example above, if bullion declines or if costs spiral out of control, then obviously you have a problem with your silver or gold producer. With the mining shares, you also have political risk, or the risk of flooding, explosions, deaths, or environmental regulations—all of which could shudder the best of projects (this is why diversification counts.) It is true that gold and silver stocks are just that: stocks. They are not a substitute for bullion.
As of this writing, investors are risk-averse: this is one reason behind the interest in bullion as an investment. However, just as crisis consciousness is not the only driver for bullion investing, neither is risk aversion going to keep people away from the mining shares forever. Barring the end of the world, I think they will eventually get their day in the sun. And in that environment, it won’t matter what the actual earnings are, what the actual feasibility of a project is, or what is going on politically. People will have gold and silver fever (like they had dot.com fever in the ‘90s) and they will grab anything with the word gold or silver in the title, as David Morgan likes to say. This irrational aspect of stock investing (speculating) may be unsettling to some, but I think it has a far larger grounding in reality than many realize. So do your homework, diversify, don't be scared, and buy some mining shares before the sleeping herd wakes up.
