Gold Miners - Value Traps In Waiting?

When searching for investment ideas, one thing that seems to work is the search for the weak hand. Relatively uninformed investors, or simply those who are making non-economic and indeed incorrect assumptions are often a good starting point to research the other side.

With that mind, the fact that the U.S. Mint has run out of small gold bullion coins to sell is particularly interesting. This is a mini gold craze which parallels the institutional interest but is unique because:

1. The small denomination implies mostly retail interest, e.g. those who don't have that much money to begin with. They are therefore forced to buy the small denomination.
2. The illiquid/indirect nature of the buying. One can buy GLD etf to get the same exposure with much higher liquidity. Given the world avoids anarchy (and even then), no one is forced to accept gold as payment and therefore is by definition fear-based buying.

Hypothesis: the buyers of such coins are relatively well-off people but non-investors. They see the ads on cnbc (you know which ones) to buy gold and hear that gold has outperformed the market in the last decade. They have never bought/traded commodities and hearing the massive money printing believe that buying gold is the prudent thing to do. However, not liking the volatility of futures they choose to buy a coin, something physical.

Gold mining stocks follow from that same defensive logic - they are real businesses after all. They make sales based on gold prices and in addition provide operating leverage. If it costs them 500$/oz to mine the gold and the price is now $1000 but then moves to 1500, their income doubles. On the other hand,  the gold price only moved 33%.

But is this leverage accurate? Consider this table from Barrick Gold's annual report (page 83)

 Cash costs increased by roughly 43% (=584/409) over two years. What about gold itself?

Gold etf (physical) increased by roughly 20%, roughly half that amount.
In other words, the world's largest miner had negative operating leverage in one of the most consistent bull gold markets in the last 20 yrs.

As a result, gold miners may be trading at low fcf and earnings multiples, but may deserve such low multiples. They may therefore be a value trap.  This is not even considering that most miners' do not have a consistently profitable business even in the last few years.


Disclosure: I am short GDX (etf of gold miners).