A Major Buying Opportunity
Jun 29th, 2006 | By Penny Sleuth Contributor | Category: Commodities, Investing StrategiesIt doesn’t happen all that often. But every once in a while, the market presents us with a no-brainer buying opportunity like the one that exists in the gold sector right now.
Last year at this time, an ounce of gold traded in the $420-440 range. As I write this Sleuth, the shiny metal is at $583 — 32% higher. Yet many gold stocks are trading at the same level (or lower) than they were two or three years ago.
Take a good look at the three price charts for IAMGOLD Corp. (IAG:NYSE), Kinross Gold (KGC:NYSE) and Newmont Mining Corp. (NEM:NYSE):
IAMGOLD is a junior mining company (market cap of $1.5 billion) with 3.9 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 $76 million more today.
Kinross is a mid-tier gold company (market cap of $3.3 million) with 19 million ounces of proven and probable reserves. It is trading for nearly the same price as it did in February 2004 even though its reserves are worth $1.1 billion more.
And Newmont, a major gold producer with a market cap of $20.9 billion and 93.2 million ounces of proven and probable reserves, trades for the same price as it did in December 2004. Yet its reserves are worth about $19 billion today, versus $18 billion in 2004.
If the fact that these stocks are cheaper now than in 2004 seems counterintuitive to you, it should. The fundamentals of the gold sector have strengthened dramatically in the last 24 months, yet gold stocks have not followed suit — at least not yet.
Something has to give.
Either gold stocks are set to tank from here if the gold rally is over (as some think is the case and as stock prices seem to indicate), or the gold rally will continue and gold stocks will catch up with their underlying fundamentals.
I strongly believe the latter scenario is far more likely. In fact, I believe we are only in Stage 2 of a three-stage gold rally. Let me explain…
The first stage of the gold rally started back in 2001. That’s when the world lost faith in the dominant global currency — the U.S. dollar — and sought refuge in a more tangible store of value. You can clearly see that in the chart below. As the dollar plunged, gold prices took off:
Of course, not many people bought gold in 2001. The mainstream never catches an idea in its earliest stages. They are too afraid of being wrong and going against the herd. So they sat on the sidelines 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 U.S. dollar gained about 9% versus a basket of other world currencies. Normally, you would expect gold to fall when the dollar rises. But that wasn’t the case. The shiny metal rose from $420 an ounce to $520.
In this second stage of the gold rally, investing in gold became acceptable in the investment community. Barclays played to the crowd by unveiling its iShares COMEX Gold Trust (IAU:AMEX) — a gold ETF that corresponds to one-tenth of a troy ounce of gold — in January 2005. And as you can see from the chart below, investors piled in shortly thereafter. Volume and money flow into the ETF steadily climbed through 2005 and into 2006. Stage 2 was in full swing…
But this past May, gold prices got ahead of themselves. Gold rose above $700 an ounce for the first time in over 20 years. People got nervous and started taking profits and the price of gold plunged back down to $567 an ounce. As a result, gold stocks got killed. Hence, you can go out and buy IAMGOLD, Kinross and Newmont today for 2004 prices.
Talk about an overreaction — and a buying opportunity.
Eventually, gold stocks will catch up with their fundamental picture. And in the short term (say, 3-12 months out), I believe there are some nice double-digit profits to be made by buying cheap gold stocks. But the real profits will come when the third phase of the gold rally begins. That’s when the mainstream public bids stocks up to ridiculous highs — a la tech stocks. When that happens, prices could easily double and triple from today’s prices.
If you believe in the gold rally, now is a great time to be a buyer. But before you go out and buy any old company, make sure you pay attention to at least these three things:
1) Sales and earnings: There are a lot of risky exploration companies that have nothing in the way of real sales or earnings. They are spending lots and lots of money in the hopes of making a large discovery. Forget them. You want to own the companies that are actually profiting from selling gold at these elevated prices.
2) Reserves: Obviously, the larger the reserves, the more gold a company has. And the more gold a company has, the more potential sales and earnings it can churn out. So pay close attention to a company’s proven and probable reserves. That is the amount of gold the company can reasonably expect to extract from the earth and turn into a finished product.
3) Location: The last thing you want to do is buy a company that has a large portion of its reserves in Venezuela, Sierra Leone or Bolivia — or any other hostile part of the world. It’s better to pay a slight premium for safety (companies with reserves in Canada or the United States, for instance) than to risk having Hugo Chavez come in and take your mine from you or force you to pay ridiculous taxes to do business in Venezuela.
You should also look for gold companies with solid balance sheets — lots of cash and little long-term debt. With gold prices so high, a good company can fund its operations in cash it’s bringing in. It should not have to borrow millions of dollars or tap the capital markets to stay afloat.
If you are interested in a few smaller-cap gold companies that meet all these criteria, I will present you with at least two names in my next issue of Small-Cap Strategy Report. I am hard at work on the issue now, and I expect it will be done in the next week or 10 days.
Regards,
James
June 29, 2006
