Why the Biggest Profits in the Gold
Bull Market Are Still Ahead
“It’s too late, the easy money has been made,” is the most common response I get from investors when I ask them why they do not have exposure to the gold bull market. Nothing could be further from the truth.
Yes, gold’s had a phenomenal run-up in price, rising from under $300.00 an ounce in 2002 to $1,480 today—a gain of 393%. I wrote these now famous words in PROFIT CONFIDENTIAL back on December 13, 2002: “I’ve been pushing gold bullion and gold shares for over a year now. Bank in January 2002, I personally started buying gold-related investments.”
And, while many investors feel that it is too late to get into the gold bull market, I continue buying in. Actually, I’ve been buying gold-related investments all the way along; most recently when gold was trading at $1,400 an ounce.
Here are two reasons why I keep buying and why I believe the biggest gains for gold investors lie ahead:
Firstly, the shares of quality gold-producing companies are lagging the rise in the price of the metal. Look at the shares of Barrick Gold Corporation (NYSE/ABX), one of the world’s largest gold-mining companies. Back in 2002, Barrick’s stock traded at $20.00. Today, it trades at $53.00, a gain of 175%, while gold bullion is up 393% in the same time period.
Same thing with Newmont Mining Corporation (NYSE/NEM), another major gold producer. Its stock traded at $25.00 in early 2002; today, it trades at $57.75, for a gain of only 130%—gold bullion, over the same time period, beat the gain three-fold.
The stock market works on supply and demand. The more demand for a certain stock or type of stock, the higher the price goes. The great majority of mutual funds in existence today are not investing in gold stocks. As time passes and gold prices continue to rise, investment professionals will start to view gold as a “must have” in their portfolio. Demand for quality gold stocks will rise. Gold stocks will start to fare better than gold bullion itself.
The second reason why the biggest gains for gold investors lie ahead has to do with the basic profitability of the major gold mining companies. Barrick, Newmont, and Goldcorp Inc. (NYSE/GG) have fixed costs at their existing mines, so their profits rise sharply as gold prices rise. Look at it this way: a gold mining company has a cost of production of $800.00 an ounce. At $1,480 an ounce for gold, the company is enjoying a gross profit of 85% on its cost of gold.
Now, if gold prices went to $2,500 an ounce (which I expect gold bullion to easily surpass), the gold mining company producing gold at $800.00 an ounce all of a sudden sees its profit margin jump to 213% and, bang…the stock price takes off.
The biggest profits in gold lie ahead, because we are still in that phase of the gold bull market where stocks are lagging the price advance of the underlying commodity. Bottom line: investment professionals still do not believe gold is worth having in their clients’ portfolios and the great majority of investors do not have exposure to gold. As we enter phase three of the gold bull market, gold stocks will start to lead, as opposed to lag, the advance in gold prices.
Michael’s Personal Notes:
It was bound to happen…
The big news this morning: New York-based Standard & Poor’s credit rating agency downgraded the U.S. AAA credit rating from “stable” to “negative.”
I’ve been writing about this coming event for months. The quickly rising national debt of the U.S., and lack of any meaningful effort to reduce our annual deficit would sooner or later cause the security of debt instruments to come under question.
How it usually works: first a country’s debt rating is cut (like the U.S. debt rating was cut today), then interest rates in that country rise to offset the new perceived risk in its debt securities (in this case, U.S. Treasuries).
First we had long-term interest rates rise, now short-term interest rates will come under pressure to rise. If the stock market goes down big-time today, which I expect it will, the reason will be the market’s increasing realization that higher interest rates in the U.S. are just around the corner.
Where the Market Stands; Where it’s Headed:
The bear market rally that followed the early 1930s stock market crash started in October 1934 and lasted until August 1937—35 months—and took the Dow Jones Industrial Average from a level of 90 to 185, a gain of 106%.
The current bear market rally in stocks started back in March of 2009 and is enjoying its 26th month of gains, having brought the Dow Jones Industrial Average up 93% so far. As I have been writing, the current bear market rally is not over yet. While upside potential is limited, there is another five percent to 14% left on the upside for this market.
The Dow Jones Industrial Average opens this week up 6.6% for 2011.
What He Said:
“If I had to pick one stock exchange that would rank as the best performer of 2007, it would be the TSX (Canada’s equivalent of the NYSE). Interest rates in Canada remain very low and they are not expected to rise anytime soon. Americans looking to diversify their portfolios, both as a hedge against the U.S. dollar and a play on gold bullion’s price rise, should consider the TSX. Most brokers in the U.S. can buy stock on this exchange.” Michael Lombardi in PROFIT CONFIDENTIAL, February 8, 2007. The TSX was one of the top performing stock markets in 2007, up just under 20% for the year.