Excerpt from “An Insider’s Guide to the Mining Sector: An in-depth study of gold and mining shares”– by Michael Coulson

To order a copy of An Insider’s Guide to the Mining Sector, please click here: http://www.harriman-house.com/book/view/66/investing/michael-coulson/an-insiders-guide-to-the-mining-sector/

Stock market cycles

We have talked earlier about mining shares in relation to stock market cycles for industrial equities. I now want to look at mining share cycles over the last thirty years or so to see where they sit in terms of overall market cycles, and whether there are any pointers we can find that could be applied in the future.

The situation that any investor wants to avoid is tying too much of his money up for long periods of time in a sector which is underperforming. Having said this, I am not backtracking on my view that every portfolio should have a core of gold shares because of their counter-cyclical role when industrial shares come under pressure. In that context the gold content acts as insurance against a general equity bear market, and the gold core, when the general industrial market is in a bull phase, will in any case represent only a small percentage of the portfolio’s value.

Australia, late 60s – the first modern mining boom

The first modern mining boom was that which ‘infected’ the Australian market in the second half of the 60s, and which eventually ran out of steam following the rise and fall of Poseidon. The bull market lasted from 1966 until 1970, and until the last year or so marched in step with strong industrial bull markets, particularly in the US, the UK and South Africa. When these markets started to collapse in 1969 the Aussie mining market, led by the nickel explorers, took over the running. So seamless was the handover that stock market strategists theorised that the whole mining share sector could be seen as counter cyclical.

Thus general investors, having run with the industrial bull market, could extend their profit-making opportunities by switching into mining stocks at the appropriate moment. Those who got out of the 60s equity bull market and switched into Aussie mining shares would have hugely enhanced their capital gains, as long, of course, as they got out of their mining shares in time as well. Few did, in the UK partly because of the penal rates of tax on short-term capital gains.

Attention turns to gold with the fear of inflation in the 70s

So strong had been the 60s equity bull market that in the UK it experienced another leg in the early 70s, topping out in 1972 at a level it didn’t see again for many years. At that stage, although interest in mining shares had revived, it was taking a different shape to the base metal led late 60s boom which had come about partly as a result of the Vietnam War which boosted base metal demand and prices. Attention, stimulated by fear of rising inflation, had fallen on gold, and it was South African gold shares that now took the spotlight. This emphasis was to continue, off and on, well into the 80s, pushing non-precious metal stocks into the background.

In fact gold shares had begun to run late in 1971 following the closing of the US Government’s gold window, at which foreigners had been able to present surplus dollars for conversion into gold at the fixed price of $35 per oz, for many years. This uptrend continued, accompanied by intermittent pullbacks, until the gold price, having started at $35, touched $200 at the end of 1974. Between 1971 and 1974, South African gold shares rose 600%, although they actually peaked ahead of the gold price in the spring of 1974. From 1972 until the beginning of 1975, equity markets around the world, particularly the UK and US, were in free fall.

In December of 1974, the UK market plunged to a level in inflation-adjusted terms not seen since the fall of Norway in 1940 in World War II. Gold shares had proved their worth as a hedge against general market weakness. Other non-precious metal mining shares did less well in what was a market desperately trying to hedge the effect of runaway inflation. As an example, between 1971 and 1974, RTZ (Rio Tinto Zinc) fell from 270p to 73p.

Gold enjoys another run in the late 70s with renewed fears of inflation and geopolitical problems

As industrial share markets began to recover in the mid 70s, diversified mining houses also rallied on the back of hopes that the return of economic growth would revive metal prices and their earnings. In fact the next big run in mining share markets was once more in South African gold shares after they bottomed out in mid 1976 in parallel with gold itself which, having hit $200, had halved. A further pressure on gold shares was the fear of race riots in South Africa spilling uncontrollably over into the gold mines of the Witwatersrand. By the beginning of 1979 the political situation in South Africa had calmed and with gold itself rising through $200 for the first time, gold shares began to run again.

Between 1976 and the end of 1980, South African golds rose by 360% with the lion’s share of the rise coming in 1979/80; gold itself rose by more than 700% over the same period. The revival of inflation and a chronically weak geopolitical situation (described earlier in the section on gold) led to a growing interest in commodities as real assets, and other non-precious metal stocks also attracted attention alongside the golds. However, whilst base metal prices strengthened, as in the mid 70s, the spotlight was primarily on gold and this spilled over into silver.

Following the topping out of gold at $850 in January 1980, gold shares fell back, but by the second half of the year another gold bull run was building up as the Iran/Iraq War threatened stability in the oil-rich Middle East. This was short-lived and the bears returned in force, so by early 1982 gold shares had fallen back to the level at which they started their last decade run in 1976. Suddenly, in barely six months South African gold shares rose by 300%. Other non-gold mining shares were also strong on the back of a sustained recovery on Wall Street supported by optimism about growth prospects for the advanced economies. After this sharp surge gold shares retraced two thirds of the rise over the following two years, bottoming out in the first half of 1985.

Gold shares soared in 1986-87 in line with broad equity markets, but…

This fall was followed by another bull run in 1986-7 with South African gold shares rising by around 200% to record levels. This happened against a background of industrial equity bull markets around the world. Consequently, the mining bull run was a broad based one and other non-gold mining companies ran strongly until the 1987 October crash in New York led to a near meltdown in global markets.

Gold shares de-coupled from the gold price, as gold shares followed the equity markets down

There was also a de-coupling of gold shares from the gold price itself which saw gold, in the wake of the October crash, piercing $500 on the upside for the first time in four years even as gold shares slumped. The gold share market continued to be very volatile even as it worked its way cyclically lower throughout the 90s. There were big runs in South African gold shares in 1989-90 and then again in 1993-4, but these were not counter-cyclical movements as equities generally were in a bull phase, albeit one with the ubiquitous wall of worry attached.

Gold shares recover their counter-cyclical nature in the wake of the high-tech crash

In the later 90s and early in the new millennium, industrial equity markets were very strong and this helped to sustain the share prices of the big diversifieds, with Rio Tinto for instance rising by over 180% between 1998 and 2000. During that period, gold shares wallowed, almost in despair as the gold price sunk below $300 for the first time since 1979. But as the equity bull market capitulated on the back of the collapse of high-tech stocks in 2000, gold shares came back into their counter cyclical own. Over the period from late 2000 until mid 2002, gold shares, unloved and heavily oversold by the end of the tech/internet boom, rose by as much as five times.

The supercycle rears its profitable head and investors lose their’s

Over the last five years, almost completely out of the blue, a bull market – some call it a supercycle– has started in base metals and suddenly mining shares of all shapes and sizes have begun to move higher. Prices of metals such as copper and nickel, which some thought were in almost permanent oversupply, rose by over four times as investors suddenly discovered China and its appetite for raw materials. Following its early decade run gold took a back seat whilst the base metals bull trend unfolded. However, in mid decade gold did put on a spurt doubling to $730 by late spring 2006.

It then fell sharply towards $500, and from late 2006 has moved steadily higher ‘filling in’ the earlier price surge. From there, in early 2008 the price broke through $1000 but subsequently fell back to around $900. Whilst base metal shares have benefited from a spate of mergers as well as surging earnings, gold shares have found the going tough with ageing operations and a weak US dollar acting as a restraint on profitability despite the rising metal price.

Platinum bull markets

Although above I have tended to concentrate on the bull runs in gold shares, there have been instances of strong markets in other mining groups. One example would be platinum shares, which are confined primarily to the major South African stocks. These have enjoyed strong cyclical runs over the last thirty years, sometimes in association with gold shares, but not always. Indeed, since platinum is used mainly in the car industry and in jewellery, its price often moves in line with economic growth trends, partly as a result of being a non-monetary precious metal in contrast to gold. Thus, we experienced robust growth in platinum shares in the late 90s when between 1998 and 2000, prices rose by almost four times. This run coincided with a rising equity market and a dull gold share market. More recently with industrial demand strong and with a very active corporate scene, platinum shares have outperformed gold shares once again.

Canadian diamond boom 1992-94

It is also important to note that mining exploration booms can have a quite separate life of their own; the Canadian diamond excitement of 1992-4, which has been mentioned before, was a case in point. The background in terms of economic growth was poor in the early 90s, and by 1992 the industry’s leader, De Beers, was suffering from a sharp fall in demand for diamonds which further soured the atmosphere. That, however, did not seem to worry grassroots Canadian investors and Continental European investors who gobbled up the stream of new issues coming to market to take advantage of the diamond rush in the North West Territories. Of course, critical to this was the large BHP/DiaMet diamond discovery at Lac de Gras (now called Ekati), and this provided the incentive for further speculation that other large discoveries might be made.

Sometimes, mining share cycles run in line with the broad market as investors conclude that economic growth will feed quickly through to demand for metals, raising production and prices. In the late 90s the UK diversified mining groups performed strongly, even as the broad stock market powered to record levels. It may be that the position of these companies within the FTSE100, arguably the third most important index globally after the Dow Jones and the Nikkei 225, is now so central that they may become less counter cyclical than might have been the case thirty years ago. Certainly, the UK mining sector has taken heart from strong metal prices and the China story, not forgetting some fairly chunky corporate activity also which has led to a rash of mergers in recent years, and it is now one of the biggest sub-sectors of the Footsie index.

Delving back into the more distant past, one of the classic examples of mining shares outperforming industrial equities was the experience of US gold shares, led by Homestake Mining, in the 30s following the Wall Street crash of 1929. The driving force behind this outperformance was due, as it was in 1974 when gold shares also outshone equities, to a complete loss of faith in the economic/financial system which drove equities through the floor and the gold price in the opposite direction. Slightly more recently, and mirroring the Canadian diamond boom and the Australian nickel boom, was the development of the Orange Free State gold field in the late 40s after the end of World War II. The substantial increase in interest and activity generated by the opening up of a major new gold field was as a result of an event unrelated to any other, and occurred during a period when equities generally were churning sideways because of post-war austerity.

END

To order a copy of An Insider’s Guide to the Mining Sector, please click here: http://www.harriman-house.com/book/view/66/investing/michael-coulson/an-insiders-guide-to-the-mining-sector/

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