As our friends at INK Research in Canada have pointed out to us, insiders at gold companies have made use of the recent sell-off in the sector to load up on shares to an extent not seen in many years.
The INK insider buy/sell indicator for gold stocks has peaked just one day after China’s initial devaluation announcement at nearly 1,200%:
INK’s gold insider sentiment indicator surges to a new multi-year high
What precisely does this indicator measure? Here is the explanation provided by INK:
“The indicator represents companies with buy only transactions divided by companies with sell only transactions of direct ownership equity securities in the public market by officers and directors (exclusive of officers and directors of subsidiaries) filed over the last 30 or 60 days. When the indicator is at 100% there are the same number of stocks with buying versus selling. At 50%, there are two stocks with selling for every one with buying. A rising indicator suggests that insiders are seeing more value opportunities emerge, while a falling indicator implies that insiders are acting in a way that suggests value is getting harder to find. An indicator peak can signal that a meaningful bottom in valuations has taken place.”
When we have previously reported on notable increases in gold insider buying over the past two or three years, short term rallies often (but not always) tended to ensue shortly thereafter. While none of the rallies that have followed on the heels of jumps in insider buying in this time period have proved sustainable so far, it is worth noting that insider buying has really gone “off the chart” this time around.
What Insiders Know
With respect to buying by insiders in a sector in which producers have very little or no control over the price of their product, one needs to keep a few things in mind. Insiders in the gold sector usually have no special insights into future gold price trends (there are a few exceptions). In fact, quite often their estimates of the extent or direction of future moves in the gold price turn out to be wrong.
Spot gold over the past 25 years – click to enlarge.
For instance, most gold mine managers appeared to consistently underestimate the extent of the gold price rally from 2000-2011, and have conversely frequently underestimated gold’s downside potential since the 2011 peak, at least initially. In the meantime this has changed again; although there is only anecdotal evidence available, our impression is that most managers are “hunkering down” and trying to ensure that their companies will survive even lower gold prices. Those who are bullish meanwhile have only very modest price targets. For instance, Goldcorp CEO Ian Telfer, who is still bullish, recently said:
“Right now we think $1,300 gold is something that you could depend on going forward.”
Obviously, $1,300 is not exactly a rah-rah bullish gold price forecast. A little over three years ago, this would still have been a bearish forecast actually. So what do insiders at gold companies actually know? Is there any value in following their activities?
One thing corporate insiders are definitely aware of is whether their companies’ shares are undervalued or overvalued relative to current gold prices. It is rare that insiders in this sector buy a lot of shares in the open market, so when they do it is a sign that there must be a quite sizable gap between market valuations and what they believe to be fair value.
The ratio of the gold price to the HUI index since 1998 – currently gold stocks are valued at an even lower level relative to gold than at the low in 2000 – click to enlarge.
Another thing many managers of gold companies may be aware of are short term trends in physical demand in the major gold importing regions. Outsiders can look at discounts or premiums paid for bullion in places like India or Shanghai, or also on the premiums and discounts at which futures contracts trade relative to spot gold (as regularly reported by Keith Weiner in these pages).
Mainly though one has to assume that insiders in the gold sector base decisions on whether to buy or sell shares in their own companies in the open market on their estimates of the value of their deposits and their estimates of future extraction costs. Obviously they have only limited influence on the latter as well, but on this front they are at least able to exercise some control.
Lastly, managers in the extractive industries have historically actually been quite astute with respect to picking good spots for buying their own companies’ shares – especially with a view toward long term performance. This is to say that they will often make purchases quite early – as they obviously base them on insights most market participants don’t have yet (this is after all why the shares are cheap enough to induce them to buy in the first place).
In short, following their lead is quite likely to pay off, but will require some patience. We remember having observed this in the oil and gas upstream business prior to the big rally in these stocks in the early to mid 2000ds.
We have even more reason now to adopt a constructive stance with respect to the gold sector. In this case the indicator isn’t a short term one, but at the current juncture it actually happens to coincide with a number of positive short term signals. Obviously the patience of value investors in this sector has already been tried rather severely. Keep in mind though that once prices do rise, they are likely to quickly make up lost ground and will probably deliver a comparatively outsized return in a fairly short time.
A fairly recent example illustrating the value of exercising patience has been provided by Japan’s Nikkei Index. Anyone buying Japanese shares based on value considerations between 2009 and 2012 was consistently disappointed by market action. However, while no returns could be achieved in those years, the index subsequently proceeded to deliver extremely large returns (obviously, one had to hedge the yen to fully participate, but even unhedged portfolios haven’t done too badly). A compound return of more than 200% over six years is nothing to be sneezed at, even if the first three years delivered a return not far from zero.
The Nikkei Index, 2005-2015. Buying value in 2009-2012 required patience, but eventually it turned out to have been worth the wait – click to enlarge.
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