Memo to David Einhorn re: Gold Miner Suckitude
- Joshua M Brown
- November 2nd, 2011
Hedge fund manager David Einhorn is accumulating the gold miner stocks and letting some physical gold go here. Here’s what he had to say on the subject via my friend JC Parets of All Star Charts:
“A substantial disconnect has developed between the price of gold and the mining companies. With gold at today’s price, the mining companies have the potential to generate double-digit free cash flow returns and offer attractive risk-adjusted returns even if gold does not advance further,” Einhorn said. “Since we believe gold will continue to rise, we expect gold stocks to do even better.”
To which I say “Tread carefully, David”. The miners are almost universally atrocious as equity investments. Far be it from me to offer advice to one of the greatest investors of our time, but I wouldn’t be acting like myself if I didn’t chime in here with my own two cents
The thing you need to understand about the gold miners is that the levels of suckitude here are pretty much unparalleled in all of finance. One of the most successful gold and gold mining investors in the world recently explained to me (off the record so I can’t say who) the following (I’m paraphrasing and there will be generalities here, live with it): Gold miners’ management teams are unique in that the C-level execs would be completely unable to run any other type of company if they were dropped into that position. The chief guys and gals at Coke could probably manage Caterpillar or Costco once they’ve had the chance to familiarize themselves with the industry a bit. You cannot say the same with gold miner execs. The truth about gold miner people is that it’s the same guys being shuffled around from one company to the next – a mine or project doesn’t pan out and they simply move on to the next firm and start all over again.
Gold mining stocks used to be thought of as “leveraged plays on gold”. If that were actually true, these stocks would have done their job for investors over the last fews years as the price of gold has soared. But these stocks have been moribund and awful, an unforgivable sin. They’ve wrecked the opportunity for their shareholders through dilutive secondaries, insider sales and hedges. $GDX is up from 56 to 60 since the first quarter of 2008, an absolute joke when you consider that the metal itself (look at $GLD) has doubled in value. The failure of the large cap miners to capture that for holders is epic and should be a much bigger story.
In fact, not only are the miners not leveraged plays on gold, now the opposite is true: they are discounted plays on gold. In fact, some of them would be worth more if there were only the actual ore reserves and no corporate apparatus sucking the good stuff out in the name of “value creation”. Perhaps this is what’s attracted Einhorn’s fund to them in the first place but he should understand that a miner will part from his mining operation when you pry the shovel from his cold, dead hands – there will be no “constructive discussions with management about unlocking shareholder value” in this sector.
Now I’m not telling you that these stocks can’t work, it’s just that they always find a way not to just when they seem poised to really get going. I am long the sector through some active managers so, believe me, I’d love to be wrong here and see the group finally deliver.
Lastly, I’d like to leave you with some humorous and insightful commentary from perhaps one of the most well-respected geologists and gold mining newsletter authors in the biz, Brent Cook. My friend Tommy Humphreys at the Venture Strategist blog shot these comments of Brent’s over to me and I thought they were great…
“If a company on their website has the American flag, the Statue of Liberty, gold bars with the American flag across them, cowboy boots with the American flag or anything about American gold that appeals to people’s patriotism, avoid them, it’s no different than politicians wrapped in the flag.”
“A red flag for me are companies that do what I call “mining the stock market”, and they’re are not serious about thier business, and they essentially, instead of building a mine, using the stock market to enhance their own pockets. You can determine this by companies that do repeated share financings where they dilute time and time again, and they pay themselves big salaries, they have big G&A, and so they’ll run the stock, and let it fall back, and run the stock, and let it fall back. So essentially what they are doing is living off a public company through salaries, options, and this constant up and down of the stock market, especially if they sell into a rising market on news.”
“Dentists always get suckered into this.”
“I draw a circle around Las Vegas, and the closer the company is located to Las Vegas, the more red flags it raises. Heh.”
Heh, indeed. Good luck, David, you’re gonna need it on this trade – these stocks are the worst (but still probably a better place to be than in the NY Mets alongside the Wilpons).
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The Reformed Broker is a blog about financial markets and the economy. Joshua Brown is a New York City-based investment advisor for high net worth individuals, charitable foundations, retirement plans and corporations... More.