Stuff Your Mattress with this Recommendation

Tweet   

I always have a watchful eye on a number of exchange traded funds (ETFs) to help me slice and dice the market’s latest moves. There is one trend that investors simply can’t ignore.

That trend is increasing gold prices.

There are a lot of gold bugs out there constantly pounding the table. They say gold is the ultimate inflation hedge, that it is a safe haven asset, and that it is extremely undervalued right now by historical measures.

Kevin McElroy, editor of The Resource Prospector (another Wyatt Investment Research free daily letter) is one of them. He’s always writing about how investors should be buying physical gold, and he’ll occasionally even recommend sources he buys through. While he’s always clear to point out that he doesn’t have any affiliation with his sources, or receive any benefits by recommending them, he is just as clear to point out how not owning gold is crazy.

He’s the kind of guy that I think (although he won’t admit it) stuffs his mattress with the golden metal. Everyone has heard the stories of how some widow sold an armoire that had bars of gold hidden in a secret drawer, or about some elderly lady that gave a suitcase to the Salvation Army, only to learn that her husband had sewn $100K into the liner.

That’s Kevin, and I’m quite certain his wife probably doesn’t know where all his money goes.  She would however, if she stopped to think about how their mattress seems to be getting more and more firm with each passing month.

For my part, I’m not as cozy with gold as Kevin is, but we both agree that to not have exposure to gold in your portfolio is crazy.

***Gold is now trading at over $1,220 an ounce, and its trend higher is unmistakable. Take a look at the five year chart of the continuous contract for gold. It is trading above both its 50 and 200 day moving averages, and the RSI is in a nice upward channel lately as well.

***So how do we profit from this trend as small cap investors? It’s time to buy…

Junior and Mid-Tier Gold Miners

These guys are the best way to play the strength in gold, because as the price of gold increases, their profit margins increase. It’s pretty simple – so long as fixed costs remain constant.

That last caveat is what small cap investors need to be careful about. It’s been said that CEO’s of gold mining companies are just liars with holes in the ground. Since ‘proven and probable’ reserves can be open to interpretation, we only want to invest in those companies that are actually pulling gold out of the ground, as well as those that keep a tight lid on expenses.

***So why did I mention ETFs earlier? Because there are two gold ETFs that you should be keeping an eye on: the SPDR Gold Trust (NYSE: GLD) which tracks gold bullion, and the Market Vectors Gold Miners ETF (NYSE: GDX) which tracks the performance of the AMEX Gold Miners index. In the GDX, you’ll find large cap companies like Barrick Gold (NYSE: ABX), Newmont Mining (NYSE: NEM), and Eldorado (NYSE: EGO), as well as a number of smaller companies.  

Both of these ETFs have outperformed the market in 2010. Year to date the GLD is up 9 percent and the GDX is up 6 percent.  Even more impressive, since the beginning of May when almost all asset classes have fallen, the GLD is up 4 percent and GDX is flat.

Take a look at the following chart which plots the GDX (right scale) against the Standard and Poor 500 (left scale), and the outperformance of miners in May becomes crystal clear.

Now, you can go out and buy the GDX to get exposure to the sector, but you’re unlikely to make the same huge percent gains that are possible with individual junior and mid-tier miners.

To do that, you need to buy small cap mining stocks.

***I own a junior gold miner in the Small Cap Investor PRO portfolio. The company expects to pull 70,000 ounces of gold from the hills of Mexico in 2010, and looking at gold prices, that translates into a bundle of cash!

In the last quarter, this company received an average price of $1,119 per ounce, and total cost per ounce was only $425. That’s a $694 profit per ounce! That’s why I love low cost gold producers, as the price of gold goes up, their margins expand. And the more gold they pull from the ground – well you get the picture.

This stock was recently featured in the Dick Davis Digest, and it may not have much longer before Wall Street really begins to take notice. It’s not too late to pick up shares however. You can get my full research report here.

***There are a lot of small cap gold mining companies out there, but many CEO’s are just liars with holes in the ground.

You need to be investing in small cap companies that are actually producing, and that are profitable. The company I’ve found boasts both aspects.

See if you can find a better gold mining company than I have. Send me your tickers; I can’t tell you what company I’ve found – you’ll have to sign up for a trial subscription to Small Cap Investor PRO for that.

But I will review your company, and let you know if I think it’s a good investment. My address is: editorial@smallcapinvestor.com.