GDX - RING: A Risky Bet Despite High Gold Prices

Summary

• The iShares MSCI Gold Miners Index faces major headwinds in the form of still-elevated valuations, weak long-term growth prospects, and an increasingly precarious gold price outlook.
• On a trailing basis, the P/E ratio on the MSCI Global Gold Miners index is 22.1x, despite profit margins being a long way above their long-term average.
• With gold prices near record highs, we will see a rise in sales across the gold mining sector over the coming months, but not sufficiently to justify current valuations.
• Over the long term, revenues of the MSCI Global Gold Miners index have underperformed the rise in the gold price as mining volumes have declined, and this is likely to continue.
• The rally in gold prices is not supported by real US bond yields, and previous such occasions have led to gold market peaks.

Gold mining stocks have outperformed gold over the past few months as is to be expected during gold bull markets, with the RING rally in gold prices since the iShares MSCI Global Gold Miners ETF (RING) rising over 50% in less than three months. RING is expensive even at current elevated gold prices, while gold itself is increasingly at risk of a downside reversal.

The RING ETF

The RING ETF provides exposure to gold mining companies, as classified by GICS, from developed and emerging markets. A minimum of at least 30 securities that do not hedge to gold prices are selected from the MSCI ACWI Investable Market Index. Compared to the VanEck Gold Miners ETF ( GDX ), RING has a slightly higher weighting of the two major components Newmont and Barrick, at 18% and 15% respectively, compared with 13% and 10% for the GDX. The lower weighting of smaller companies makes the ETF slightly less volatile. The dividend yield has fallen to 1.1%, but this should rise as the MSCI Global Gold Miners index itself yields 2.5%.

Earnings Will Rise But Not Enough To Justify Valuations

On a trailing basis the P/E ratio on the MSCI Global Gold Miners index is 22.1x, despite profit margins being a long way above their long-term average. With gold prices near record highs we will see a rise in sales across the gold mining sector over the coming months, but even if profit margins return to record highs, the RING would still not be particularly cheap. If we assume that sales per share rise back to their all-time highs seen in mid-2022, this would put the price-to-sales ratio at 2.4x, which is still above the 10-year average. Even if costs remain flat even as miners expand production as new projects become profitable, this would put profit margins at 18%, which would match the peak seen in mid-2021, resulting in a P/E ratio of 13x.

While this would make the RING cheap from a historical perspective, investors should take into account the long-term trend of falling real output. Over the long term, revenues of the MSCI Global Gold Miners index have underperformed the rise in the gold price as mining volumes have declined. This is true even of NEM and GOLD, despite the large number of acquisitions seen over the past decade. We should expect mining production to decline over the long term as available gold discoveries dwindle. There is also little hope for technological advancements in the industry to bring down costs significantly, which should mean earnings will likely decline over the coming year in the absence of ever rising gold prices.

Gold Prices Face A Downside Reversal

A downside reversal in gold prices is looking increasingly likely and could wreak havoc on gold mining stocks that are priced for perpetual gold price gains. As I noted recently in ' Sell Gold And Buy TIPS ', the rally in gold prices is not supported by real US bond yields, and previous such occasions have led to gold market peaks. This can be seen in the chart below. which shows the fair value of gold prices (adjusted for inflation) based on their correlation with US 10-year inflation-linked bond yields.

On this metric, real gold prices are more than double their fair value, which makes the metal more overvalued than at the 2011 bubble peak. This does not at all mean I expect gold prices to fall by half as there are many other factors to consider, but it should be a warning sign to investors chasing the current rally.

Summary

The RING ETF has had a good run over the past few months but it now faces major headwinds in the form of still-elevated valuations, weak long-term growth prospects, and a highly precarious gold price outlook. After having been bullish gold mining stocks off and on since the Covid crash, I am now outright bearish the sector, and believe that RING is a sell at present.

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