Sprott Asset Management is out Wednesday with another rosy view of the gold market, maintaining that “the fun has only just begun,” especially when it comes to equities.
The firm's argument centres on the fact that while the commodity has risen about 20 per cent since the start of 2010, gold stocks - even some of the biggest names in the industry - have significantly trailed its performance.
Sprott points to the NYSE Arca Gold Bugs Index , which is designed to give investors exposure to near-term movements in the gold price by focusing on companies that do not hedge production beyond 1.5 years.
Despite a 35-per-cent increase in the price of gold since March, 2008, the HUI is still trading close to the same level as when gold was barely over $1,000 (U.S.).
Sprott points out that any increase in the price of gold above a producer’s total cost per ounce significantly increases a company’s net income in percentage terms. For instance, a gold producer with cash costs of $500 per ounce can generate a earnings before interest, taxes, depreciation and amortization (EBITDA) of $500 an ounce mined when gold is fetching $1,000. But most mining companies have extra costs on top of their operating expenses. A new gold project may have extra expenses that will add another $300 or so to costs, so a miner only generates $200 of margin.
With $1,350 gold, however, and the same cost structure of $500 in operating costs and $300 in additional costs, a gold company’s margins will rise from $200 to $550 an ounce, a gain of 175 per cent.
“We don’t believe current gold equity valuations reflect this potential margin increase at all, but they soon will. A re-rating is just around the corner,” said Sprott.
To boot, Sprott said HUI’s recent relative underperformance to gold is not in line with historical trends, and HUI technicals are also signaling a bullish uptrend.