There have been several reasons:
2. As doubts about the future of the U.S. and global economy were raised and overall, all share prices fell because they had already discounted a tremendously rosy future for corporate America, so all share prices, including mining shares, suffered and will do so as long as this view is held.
3. Investors for the long-term are usually institutions that have to produce a return for their future pensioners or clients. These returns come from capital gains [rosy future high capital and income expectations] and income. With the very high P/E/ ratios we saw in the markets, the emphasis has shifted almost completely away from income to capital gain. Now that the harsh reality that the future is not so bright and that the dividend-flow is hopelessly low, the unbridled enthusiasm of former times to buy shares has dimmed tremendously.
4. A now old-fashioned formula starts to raise its head again as we saw interest rates rise last year. The relationship between overall rates of return on fixed interest securities and on shares showed that while capital values may have fallen, the return on new money invested rose along with interest rates. But then throw in inflation and these rates did not look good either. So no wonder investors are rushing in search of new homes for their money, such as cash or short-term T-bills, rather than equities. Mining shares suffer too in this change of investment climate. A graph of dividend flows to interest rate returns clarifies this picture. We do not include one here, as there are so many different instruments to use, but overall the lower risk [or so previously thought] fixed investments performed as well, if not far better, than overall equities. But now toss in inflation and both begin to look poor.
You may well now retort, “but the mines will do better than other sector equities”. And you would be right, but when? Take a look at what a mine will earn from last year’s gold or silver market and ask yourself what price was this based on? We are now beginning 2008, so what price will this year’s income be based on? It is the average price of gold or silver in the company’s year that will decide what the company earns after tax and from which they will or will not pay dividends.
It is not the gold price on any particular day in 2008. We have a tendency to assume that today’s price will be the average going forward and that the share price should reflect today’s gold & silver price. It doesn’t and savvy investors keep a watchful eye on that average price, because it is that, that will dictate their total return [Capital in the context of equity market conditions – Income in the context of dividends paid].
But as Investors, you have to be careful in falling equity markets. The rosy future is no longer in front of us [until we actually see it reappear after the stimuli have taken effect - interest rate cuts & tax stimulus, which may be some months in coming still], so we turn back to the grimy reality of income earned on our investments, which rises in importance as capital appreciation wanes.
We have to ask ourselves: -
• Will the mines pay a dividend or are they extending the life of the mine at the expense of dividends?
• Will dividends come in the future, if so when?
• Will the mining companies policies lead to capital appreciation?
It is total return we are after and that varies with the investment climate and expected return on investment.
You could reply, correctly that gold & silver shares have a rosy future and will pay rising dividends too [check company policy on their website to confirm that]. And so they should. But the real joy of the gold & silver shares will come when other sector shares are looking at a dull future, when gold shares are not. What makes us have confidence in gold & silver shares then if other equities are looking disappointing in the face of a possible recession?
During the fall and once equity markets have seen the worst of their falls, good investors will be looking around for shares that will behave well during and after such falls. With gold & silver shares seeing an average gold & silver prices rising steadily [much faster than rising costs] and a long way still to go before today’s gold & silver prices are reached, let alone expected prices, gold and silver shares are on a growth in income, path. As the reality of the average gold & silver price turns into present income, so gold & silver shares will be attractive.
If the gold & silver market continues to evolve into a sector that is seen as a more than a volatile, speculative sector into longer-term reliable performers, contrary to other equities, we will see gold & silver shares outperform other sector shares and rise alongside the average gold & silver price.
But before that happens, investors have to be convinced that the gold and silver price rises is here to stay and that present prices of gold and silver will hold. We believe they will!