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With growing optimism in the market regarding the possibility of averting the U.S. fiscal cliff, gold rebounded on Thursday and traded within a narrow price range after suffering its biggest daily decline in three weeks on November 28. On Friday, the gold prices saw a decline once again.

Although gold was not able to break the $1750 an ounce level last week and plunged to as low as $1705.64 an ounce on November 28, the bullish sentiment with regards to the yellow metal remained, as is evident from record holdings in the gold backed exchange traded funds.

According to the data collected by Bloomberg, holdings in gold backed ETFs increased to the record level of 2,615.89 metric tons on November 28. John Boehner, the Republican House Speaker, is hopeful that the Republicans would be able to broker a deal with the Democrats sooner rather than later, and they will be able to avoid the crisis. Treasury Secretary Timothy Geithner, on the other hand, met congressional leaders on November 29 to fend off a combination of $607 billion of spending cuts and tax increases that may be enforced in January next year.


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"The whole environment around the fiscal cliff is very uncertain," said Bjarne Schieldrop, the Oslo-based head of commodities research at SEB AB. "The fiscal cliff will be on and off every other day. Most likely it won't be resolved before the first quarter, but I think that the general direction for gold will be up. Record ETP holdings and central bank buying are giving good support to the sentiment."

After fell 1.3 percent on Wednesday 28th November due to a heavy bout of stop-loss selling and concerns pertaining to the conclusion of a deal on the fiscal cliff, sending the U.S. economy back into recession.

No Fat Finger

The CME group operates the U.S. COMEX and gold futures markets. The group ruled out the possibility of a human error or a fat finger behind Wednesday's plunge in price. "It was not a 'fat finger'. The market sold off. No stop logic triggered either, which meant that the price decline wasn't even fast enough to trigger a pause on Globex," said a spokesman for CME referring to the group's electronic trading platform

The reasons behind the gold rally are as follows: Central banks are buying gold and there is still a huge amount of liquidity in the system supporting higher gold prices. The uncertainty surrounding the fiscal cliff may increase gold prices further.

"Generally people are still pretty bullish on gold and last night was just a one-off correction, nothing extraordinary," said a Singapore-based trader, adding that $1,650-$1,700 would be a good buying level.

As we mentioned in our previous articles on gold, the precious metal is headed for its 12th straight annual gain. The yellow metal increased 10 percent YTD as central banks of Japan, Europe and the U.S. took steps to promote growth. In the last two rounds of quantitative easing, the Fed bought $2.3 trillion worth of debt, sending gold prices up by more than 70 percent, and the open ended nature of QE3 is only going to increase gold prices further.

Gold Equities

Among the gold equities under our coverage, Barrick Gold (NYSE:ABX) and Yamana (NYSE:AUY) have won our buy rating, and we have a neutral rating on Newmont (NYSE:NEM).

Yamana Gold

We have a bullish stance on AUY based on its increased production, very sustainable dividend yield and long term growth prospects. AUY is up 24 percent YTD while ABX and NEM are down 26 percent and 24 percent, respectively. The company pays a dividend yield of 1.3 percent.

Barrick Gold

We are bullish on ABX for long term investors because of its resource and reserves base, which is the largest in the industry. Its production base for gold is expected to be more than 8 million ounces per annum by 2015, once Pascua-Lama (PL) and Pueblo Viejo are in full production. The company has an attractive dividend yield of 2.3 percent and is trading at cheap valuations, as compared to its peers.

Newmont Mining

NEM's woes are twofold; rising costs and diminishing production. We have a neutral rating on NEM because we believe that it has a stable base of operations in North America and Australia; however, its production is declining and it is facing cost pressures, especially in its APAC operations.

Financials

ABX is trading at a forward P/E of 6.9x while AUY and NEM are trading at 12.9 and 9.4, respectively. Out of these three, NEM offers the highest dividend yield of 3 percent, whereas ABX offers 2.3 percent. While both ABX and NEM are down YTD, AUY is up by 24 percent.

Comp Sheet

ABX

AUY

NEM

Forward P/E (1 year)

6.9x

12.9x

9.4x

PEG ratio (5 year expected)

N/A

2

N/A

EV/EBITDA (TTM)

6.8x

12.2x

6.1x

Dividend yield

2.3%

1.3%

3.0%

Long-term earnings growth rate

N/A

10.7%

N/A

Share price Performance (YTD)

-26.5%

24.0%

-24.2%

Conclusion

The uncertainty surrounding the fiscal cliff, central banks buying gold and the fact that there is a lot of liquidity in the market will support gold prices. We remain bullish on gold and the two gold equities mentioned above.

For a detailed analysis on ABX and AUY, please refer to our earlier article on these two stocks, and for NEM, please read this article.

Source: Reasons Remain For A Gold Rally: 2 Gold Stocks To Buy, 1 To Avoid