Investing in gold stocks
James Boric - Thu 02 Nov, 2006
...The third stage of this metals rally has yet to begin. But when it does, it will be quick, explosive and very lucrative...
The most profitable stage of the gold rally - stage three
- has not yet begun.
The first stage of the recent metals rally began in 2002.
That's when the world lost faith in the US dollar - the
dominant currency of the world. Of course, it didn't
happen all of the sudden. Leading up to 2002, the stock
market crashed, US debt piled up to all time highs and the
trade deficit swelled to epic proportions.
All of these factors, coupled with the geopolitical
concerns around the globe, led foreign central banks and a
handful of shrewd investors to question whether holding US
dollars was really a safe thing to do. A few brave souls
decided it was not. So they smartly sold their paper
assets (dollars) and bought gold - a true store of value
in uncertain times.
For the first time since the 1970s, both demand and the
price of gold increased significantly as the value of US
dollars fell in half. This marked the first phase of the
metals rally.
Of course, not many people bought gold (or any precious
metal) in 2001. The mainstream never catches an idea in its earliest
stages. People are too afraid of being wrong and going
against the herd. So they wait for confirmation from
mainstream before they buy. That is exactly why noticeable
buying didn't occur in the gold markets until late 2004
and early 2005 - when the second stage of the gold rally
began.
By 2005, global demand for gold was large enough that spot
prices actually rose no matter what the dollar did. For
instance, in 2005, the US dollar gained about 9% versus a
basket of other world currencies as it bounced off its 10-
year low and as the US stock market rose. Meanwhile, the
shiny metal rose in tandem with the dollar - from $420 an
ounce to $520.
This divergence from the US dollar coupled with the first
signs of retail interest in gold and silver as a
legitimate investment opportunity marked the second phase
of the metals boom. During the time, Barclays unveiled its
iShares COMEX Gold Trust ETF and the first-ever silver
ETF. Since that time, money flow and volume for the gold
ETF proves that there is interest in gold as an investment
vehicle.
Average daily volume for IAU has more than doubled in the
last year and total assets have gone from nothing to $1.2
billion. But this interest in gold is still very tiny.
Wal-Mart alone is a $200 billion company! In other words,
despite the interest that has been drummed up in the gold
world to date, it is hardly indicative of a mainstream
rally.
The third stage (the "mainstream stage") of this metals
rally has yet to begin. But when it does, it will be
quick, explosive and very lucrative. To understand what
this mania phase will look like, we turn back to the
1970s. During the last metals boom, stocks rose fast and
furiously in the final stages of the metals rally.
* Bankeno rose from $1.25 to $430 a share
* Resources rose from $0.40 to $560 a share
* Steep Rock rose from $0.93 to $440 a share
* Mineral Resources rose from $0.60 to $415 a share
* Azure Resources rose from $0.05 to $109 a share
* And Leon Mines rose from $0.05 to $385 a share.
Although many small-cap gold stocks have already risen
hundreds of percent since 2001, we have not yet seen
mania-buying like in the late 1970s. In fact, since May of
this year, gold stocks have sold off to several year lows,
despite better underlying fundamentals.
Last year at this time, an ounce of gold traded in the
$470 range. As I write this essay, the shiny metal is at
$601 - 28% higher. Yet many gold companies are selling for
less than they were 12 to 24 months ago. For instance...
IAMGOLD is a junior mining company (market cap of $1.5
billion) with 4.6 million ounces of proven and probable
gold reserves. At $8.50 a share, it is trading for the
same price it traded for back in December 2004. Yet its
reserves are worth $430 million more today.
Bema Gold is a mid-tier producer with 11.4 million proven
and probable ounces of gold in the ground. Based on FY
2005 numbers, those reserves are worth an estimated $4.9
billion. Yet, Bema stock is trading for the same price as
back in Dec. 2003 - when its reserves were worth about
$1.1 billion.
And Newmont, a major gold producer with a market cap of
$20.1 billion and 93.2 million ounces of proven and
probable reserves, trades for the same price as it did in
Sept. 2003. Yet its reserves are worth about $4.1 billion
today, versus $2.9 billion in 2004.
This price action is not, in any way, indicative of a
fierce, mainstream metals rally. While the price of gold
has significantly increased in the last year, mining
stocks have not followed suit.
As investors, you have a choice to make.
You can invest in gold stocks now - before the third stage
of the rally begins (and while prices are trailing the
overriding fundamentals). Or you can wait for confirmation
from the herd.
Those who buy now must have a stomach made of steel,
patience and a thick skin. While it may be a rollercoaster
in the short term, it will be these people that walk away
with the largest profits in the end.
Of course, those who buy now will only have one group of
people to thank for their riches - those that wait for
confirmation from the rest of the market before they get
in.
Regards,
James Boric
for The Daily Reckoning
