Is the Canary in the Gold Mine Coming to Life Again?

A Chirp from the Deep Level Mines

Back in late 2015 and early 2016, we wrote about a leading indicator for gold stocks, namely the sub-sector of marginal – and hence highly leveraged to the gold price – South African gold stocks. Our example du jour at the time was Harmony Gold (HMY) (see “Marginal Producer Takes Off” and “The Canary in the Gold Mine” for the details).

We actually mentioned an earlier breakout attempt in these pages that ended up getting rejected the very next day, after GFI (Goldfields) reported earnings the market didn’t like at all. In particular, the company had to admit that it was still failing in its efforts to make the South Deep mine (its largest asset by far) profitable. The index promptly nose-dived to a new interim low. This time we decided to wait until after the breakout, to avoid jinxing it again.

JSE Gold Index Breakout, Feb 2018 - Oct 2018

South African gold mining stocks break out with authority. - Click to enlarge

The JSE Gold Index is following the lead of the JSE Platinum Index, which had already broken out ahead of it in September, as no negative surprises were reported by its major constituents. To be sure, there were a few bad earnings reports in the platinum sector, but nothing unexpected occurred. In fact, after posting a huge headline loss due to taking large write-offs and announcing a major restructuring of its flagship Rustenburg mine, the stock of Impala Platinum rallied quite strongly. Here is a chart of the platinum index:

While we cannot be sure why investors have suddenly become enamored with the precious metals sector, it is probably a good guess that gold stocks are by now so cheap that they are considered a worthwhile target for rotation purposes. As an aside, South African gold mining stocks are of course rallying in USD terms as well, but there remains a lot more overhead resistance they need to overcome, as their advance was partly driven by weakness in the South African currency.

JSE Platinum Index, Feb 2018 - Oct 2018

JSE Platinum Mining Index. Another noteworthy breakout over an initial resistance area. - Click to enlarge

More Ground to Cover

Below are two examples, namely HMY and SBGL (Sibanye-Stillwater). Both are well off their lows (and slightly overbought by now), but have yet to reach new highs for the year. A lot of ground will have to be covered to get to that point, particularly in the case of SBGL. HMY is actually not that far from its April peak in USD terms.

As an aside, Harmony has reported excellent earnings for several quarters in a row, but we suspect the stock was held back because the company bought a large mine from Anglogold (AU) earlier this year and had to fund around 50% of the purchase by issuing new shares. We would note that it bought an excellent asset at a very low price (in other jurisdictions it would have paid a lot more) and managed to retain a quite pristine balance sheet in the process.

Harmony Gold Mining, Daily, Nov 2017 - Oct 2018

HMY – a spirited rally in USD terms as well since hitting an abysmal low in August. - Click to enlarge

Sibanye Gold Ltd. daily Nov 2017 – Oct 2018

Sibanye Gold Ltd. daily Nov 2017 - Oct 2018

SBGL was also beset by a number of company-specific problems this year, partly related to its takeover of platinum miner Lonmin, but it seems it is getting a grip on them. - Click to enlarge

Conclusion

South African precious metals stocks look a tad overbought in the short term, but one has top keep in mind that they have a well-established historical tendency to both decline and rally very strongly and quickly. When these stocks are particularly strong, it is often a positive medium term signal for the sector as a whole, the potential for short-term volatility notwithstanding.