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Are Shares of Gold Miners a 'Buy'?

Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”
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"A gold mine is a hole in the ground with a liar standing on top of it."

-- unverified quote attributed to Mark Twain

A few weeks ago, we discussed how gold can't seem to catch a break. Despite a parade of potential market-roiling news, the reaction of the shiny yellow metal has been one of benign indifference.

After Federal Reserve Chair Janet Yellen's testimony about the likelihood of an interest rate increase sometime this year, gold fell for a fourth consecutive day. Gold now trades at about $1,142 an ounce. Aside from a three-day stretch in November 2014, gold hasn't been below $1,150 since 2009.

This isn't going to be a goldenfreude column, gloating over other people's losses. I have addressed issues in the gold-bug complex repeatedly (see this, this, this, this, this, this, and of course this). Instead, I want to consider the gold miners to determine if, after the fall in the price of gold, there is any value to be found there. 

What got me thinking about this was a fascinating chart below, courtesy of Isaac Arnsdorf yesterday at Bloomberg News.

Despite the strong dollar and subsiding geopolitical tensions, gold as of yesterday was only down 3 percent so far this year. That compares with a drop of almost 17 percent during the same period for shares of miners, as measured by the Philadelphia Stock Exchange Gold and Silver Index.

That makes the miners the cheapest they have been relative to gold in at least three decades. (Gold and the miners began going their own separate ways not too long after the SPDR Gold Trust was introduced in November 2004. Whether that's a significant factor or merely a coincidence has yet to be determined, but I suspect it's the former.)

Does this make the gold miners a buy? To answer that question, you have to make three correct guesses.

They are:

1) Where are gold prices headed?

2) Will the longstanding ratio between mining share prices and the price of gold revert to the mean?

3) If the ratio does return to historical norms, will that happen because of price changes in the metal, price changes in the shares of the miners or both?

My answer to all three is: "I have no idea." Are the miners leading gold down? Maybe. Of course, gold could also be signaling that the miners are cheap; maybe the miners' shares will rise, sending that ratio toward its historical average during the past 30 years. Or maybe the miners could indicate that gold remains pricey, and the ratio could shift by gold going lower still. Or perhaps the ratio is a broken indicator and no longer meaningful.

The trouble with valuing the gold miners is a derivative of the issue with gold itself: I simply don't have a reliable way to value the metal. I suppose we could try to value the miners by looking at traditional metrics, such as the price-earnings ratio or book value. However, two highly random, unknowable inputs -- the price of the metal and the accuracy of total reserve estimates -- are so critical to valuing the miners that the usual valuation measures become slave to these data points. 

Owners of the gold miners need to recognize exactly what they are doing -- making multiple speculative forecasts, not investments based on probabilities.  

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Barry L Ritholtz at britholtz3@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net