If you haven’t yet bought gold
- Gold still $1000 off its inflation adjusted highs
- Gold stocks falling behind - are you buying?
- 20-100 per cent upside if gold stays above $1100
"Gold Loses Some Appeal"
That's the headline from a story in The Wall Street Journal just a few days ago, on September 10, 2010.
Gold dipped 0.4% on the Comex division of the New York Mercantile Exchange to $1,246.50 an ounce.
That's still close to the dollar denominated high of $1265 reached in June.
I just bought some physical gold during the dip back in July, and I do plan on buying during future dips - but I wouldn't recommend buying gold necessarily at this point.
Even though the yellow metal is about $1000 off its inflation-adjusted highs of $2251 reached in 1980, I hesitate to recommend buying physical gold at these levels.
The good news is that there are plenty of gold securities you can buy that are still relatively inexpensive. That's because gold stocks tend to lag gains made in the price of the underlying commodity.
I've been repeating the above statement for many months now, but it's true. Here's a chart showing gains made in the price of gold (in red) vs. gains made in the price of the largest gold stocks (in blue) between 1999 and 2007.
You can see how the bull market in gold over this period was magnified nearly two-fold in gold stocks.
But since September of 2007 gold stocks have been lagging gains made in the price of gold.
You can account for some of the under-performance by looking at the huge sell-off in all stocks in 2008-2009. Since then, gold has nearly doubled, while gold stocks are flat:
But $1200+ gold is hugely profitable for gold mining companies. Most gold miners are profitable as long as gold is north of around $600. That's about the average amount of money it takes to mine and refine one ounce of gold and bring it to market.
Anything over $600 is pure profit. That's why gold miners are able to multiply gains made in gold: their earnings go up by an incremental factor over and above their costs of production.
A quick example:
If gold prices are $1000 an ounce, the average gold miner makes $400 per ounce in profit. But if gold rises to $1200 an ounce, they make $600 in profit, or 50% more! Gold rose 20%, and gold miners make 50% more profit. That profit is eventually reflected in the stock price, but there's a lag.
The lag can be accounted for because of two reasons: it takes time for gold miners to increase production to take advantage of increasing prices, and most fundamental analysts (the guys who set price targets on Wall Street) determine a stock's price target based on the present value of future cash flows - the stocks will move higher once these increasing future cash flows become more reliable.
What's the downside?
Gold miners take a commensurate hit when gold prices slide. That increased profitability (future cash flows) can just as easily turn into decreased profitability (lower future cash flows), and gold stocks tend to get punished accordingly.
So, the trick is to find companies with the lowest costs-per-ounce, and to buy them on dips after gold falls.
Right now, gold stocks are severely lagging the gains made in gold's price. If gold stays above $1100, I expect gold stocks in general to move at least 25% in the next six months. That's not speculation, it's simply where gold stocks should be to catch up to gains in gold's price. If they multiply gains in gold's price - as they typically have done over the past 10 years, then you're looking at a potential 100% gain, or a double.
That's just the average gain. You can shoot for average by simply buying the Market Vectors Gold Miners ETF (NYSE: GDX). This ETF is comprised solely of the largest publicly traded gold mining companies.
If you're interested in an investment with a little more upside, then I'd recommend taking a look at a company Chief Investment Strategist Ian Wyatt recently added to his Small Cap Investor Pro portfolio. It's a small North American gold mining company with one of the lowest costs-per-ounce of any gold miner: around $450.
But right now this company is trading at a substantial discount to its gold reserves. Buying them today is like buying their gold in the ground for less than $200 an ounce. Like most publicly traded gold companies, they're lagging gains made in gold's price. Gold made 15% gains so far this year, but Ian's favorite gold stock is actually down 5%.
It's a great time to be buying low cost gold producers. You can click here to read the rest of the story.
Good Investing,
Kevin McElroy
Editor
Resource Prospector
