The Modern Day Gold Rush
 
Recap, the last post concluded:

• A high cost producer has a higher rate of leverage for increased earnings through a gold bull market than a low cost producer.
• A low cost producer trading at 25 time earnings already had an enormous premium to their share price at the beginning of the gold rush.
  

The idea that gold stocks should trade at bubble valuations of 25-30 times earnings has remained constant as the price of gold has increased.  As long as people continue to buy into the idea it certainly ensures that those who bought their gold stocks early see much higher returns on their investments, but how has the leveraged increase in earnings changed for the investor who buys in when gold is say $600/oz, or even $1000/oz?  Is that ideology a good ideology for late entry investors?

The next tables look at the leverage of earnings for later entry investors for the same four theoretical companies from the last post.

Gold Price	% Up	Company A (Cost $100/oz)	% Up	Company B (Cost $200/oz)	% Up	Company C (Cost $300/oz)	% Up	Company D (Cost $375/oz)	% Up
$600		$500		$400		$300		$225
$700	17%	$600	20%	$500	25%	$400	33%	$325	44%
$800	33%	$700	40%	$600	50%	$500	67%	$425	89%
$900	50%	$800	60%	$700	75%	$600	100%	$525	133%
$1000	67%	$900	80%	$800	100%	$700	133%	$625	178%

Gold Price	% Up	Company A (Cost $100/oz)	% Up	Company B (Cost $200/oz)	% Up	Company C (Cost $300/oz)	% Up	Company D (Cost $375/oz)	% Up
$1000		$900		$800		$700		$625
$1100	10%	$1000	11%	$900	13%	$800	14%	$725	16%
$1200	20%	$1100	22%	$1000	25%	$900	28%	$825	32%
$1300	30%	$1200	33%	$1100	38%	$1000	42%	$925	48%
$1400	40%	$1300	44%	$1200	50%	$1100	57%	$1025	64%

Each table shows that the leverage on earnings declines as gold prices increase.  Indeed, last post showed that for Company D when gold went up from $400 to $800, it had a 1600% increase in earnings.  But for buying in at a gold price of $1000 that same $400 increase results in a mere 64% increase in earnings, a whopping 25-fold decline in leverage!

So, buying in at $600/oz at bubble valuations of 25 times the earnings, or earnings of 4%, have the result that if gold goes from $600-700 company A can expect to see earnings go from 4% to 5% and company D can expect earnings to go from 4% to 5.8%.  And a $100 increase from buying in at $1000/oz at bubble valuation levels of 25 times the earnings has company A expecting to see earnings go from 4% to 4.4% and company D go to 4.6%.

Conclusion:  The leverage of earnings declines rapidly as the price of gold increases when bubble valuations of 25 times earnings remain constant.  Buying in at bubble valuation levels for late entry investors has dramatically reduced leverage outcomes that result in utterly marginal effects on overall earnings per share.

And, what happens if costs increase?  Mining companies mine the most profitable parts of their reserve first, it simply isn't reasonable to expect costs to remain constant as mining companies move to mining the lower yield parts of their properties.

Next post, the effects of leverage when costs go up.