Gold Stocks - The Next Winners

Gold Stocks - A contrarian view on where the next Gold Stock winners will emerge.

Searching for the Golden Goose?

For years we have been speaking and writing about the massive bind the Fed now finds itself in. With price inflation rising – read as food and energy skyrocketing -- and little hope for nominal interest rate increases – read as housing too weak for higher rates – negative Real Interest Rates (nominal rates less inflation) looks set to persist for some time.

Now why is that important?

Firstly, not only do negative real interest rates make holding non-income producing assets such as Gold attractive, but an environment where inflation is allowed to have its way and economic growth is sick (stagflation), is tantamount to the perfect storm for Gold Stocks and other Precious Metals!

So what do you do?

You load up on assets leveraged to the price of Gold – namely Gold stocks.

Wrong!

As Old Gold Bulls we have seen this situation before. A low growth high inflationary environment is poisonous for equities – Gold stocks included. And whilst the storm persist in the equity markets it will either drag gold stocks lower or prevent them from fully expressing themselves to the upside! That’s why we encourage investors to have a portion of their portfolio exposed directly to the metal either through ETFs, Futures or Physical:

Chart 1 - Since July 2007 the S&P (red) has been moving lower and Gold the Metal (green) has outperformed Gold Equitites (red and black)

Hunting Elephants

There is no doubt that an equity risk premium has weighed heavily on Precious Metal equities and that stabilization in equity markets would certainly benefit such stocks. But that’s old news.

What we consider interesting and downright fascinating is the nature of Gold Equities investors should be focusing on over the next year.

Conventional wisdom is that the juniors are where the investment gems lie. We don’t disagree – entirely.

Over the longer term (3-5 years) the fundamentals certainly favour late stage explorers and emerging producers, but an overlooked market dynamic causes us to lean rather towards their larger cousins.

As we have alluded to above, Gold Stocks and other Precious Metal equities are equities and more often than not subjected to the same forces as the general equity market. One such force is the veritable WALL of passive indexed money. By some accounts amounting to several TRILLIONS of Dollars.

And what’s the passive indexed money saying?

Chart 2 - large caps now outperforming small caps

Firstly it’s saying that the long period of outperformance by small caps versus large caps (chart 2 is falling) bottomed in 2006 and the trend has since been towards large caps.

Secondly...

Chart 3 - large cap growth has outperformed value since late 2006

The trend in large caps from value to growth (chart 3 is falling) also looks to have bottomed around late 2006. We define growth as earnings growth of +15% p.a. and/or PEG ratio of around 1.5.

These trends resonated well with us as large cap Gold producers beat out small cap miners over the last year leaving many a gold stock speculator highly frustrated.

Where to find such Elephants that will benefit from these trends?
We would begin by looking at components of the Gold Stocks ETF (GDX) or the Amex Gold Bugs Index (HUI).

Gold stocks and more commentary follow for subscribers…

Chris Vermeulen

[email protected]

I am a trader and newsletter writer specializing in the price of gold GLD ETF, Junior Mining and Energy Stocks listed in the US, Canada and Australia.