Gold: Mining Stocks Will Outperform Bullion On The Next Leg Up

Includes: EVOGF, GDXJ, GG, GLD
by: Simit Patel

Finally, it looks as though we're seeing some positive price action in gold (NYSEARCA:GLD), and that it may be time to start accumulating for the next leg up. Of course there are no guarantees, but with support at $1,550 and $1,520 being defended with strength by the bulls, with price managing to climb back above the 10 MA on the daily time period, and with the underlying fundamentals that have driven this 11-year bull market only getting stronger - i.e. debt levels continue to rise, money supply continues to rise, warmongering continues to rise - the signs are in place for the bulls. Those with a speculative disposition will have their exit signs if bulls do not defend $1,520 on any near-term sell-offs.

Of course, for the next leg up, I suspect the real opportunity will be in mining stocks - specifically sitting atop lucrative mines that are just kicking into production. Junior mining stocks, as tracked by the GDXJ ETF, are basically flat over the past two years. They also saw a much more pronounced sell-off relative to bullion in the recent correction we saw in Q4 of 2011.

Of particular relevance to stocks is the condition in the U.S. Treasury bond market. Legislators have made virtually no progress in cutting spending. As such, deficits will only rise, and the need to find more borrowers thus continues.

Moreover, interest payments on outstanding debt are set to rise, so the debt burden will only become more substantive. They were $454 billion - over 11% of total U.S. federal government spending - in 2011, and the problem gets magnified when one considers that $3 trillion in U.S. Treasury bonds will mature in 2012.

To me the situation is ripe for a panic exodus out of the bond market at some time, only to be greeted with capital controls that attempt to thwart this process in some way. The severity of any capital controls is the big question, though I suspect all this activity will be bullish for stocks - particularly gold mining stocks. It is the condition in the bond market that is the primary reason I believe mining stocks will lead the way in 2012. The recent sell-off is the icing on the cake, ensuring that sentiment and price favor buying.

The flurry of capital out of bonds and into stocks should particularly favor mining companies that can issue dividends. Such companies will be magnets for the risk-averse capital in bonds. Appreciation in share price that these companies can enjoy will position them well to acquire promising exploration firms.

With this as the backdrop, here is what I'm particularly looking for:

1. Dividend-issuing producers with sizable cash on hand, insignificant debt, operations already in production, and low cost per ounce. Goldcorp (NYSE:GG) is a great example.

2. Explorers with cash and insignificant debt, operations near a major producer and/or a major producer already a shareholder, and a top-notch management team with geological talent. Evolving Gold (OTCPK:EVOGF) is a company I previously cited as an example.

While I believe the upside is extraordinary and perhaps life-changing, so is the volatility. Chasing is a bad idea, and so the patience and discipline to buy on dips is essential. Now is a great time, though I suspect volatility will only increase, and that future dip-buying opportunities will emerge.

Familiarity with the basics of technical analysis will be a worthwhile investment to help identify when stocks are overbought and oversold. Buying good companies after sell-offs, though, is a viable strategy for those looking to buy and hold until a mania emerges and a parabolic run up in price occurs - one I suspect will dwarf the previous bubbles in the U.S. housing and IPO sectors.

Disclosure: I am long GG, OTCPK:EVOGF, GDX, GDXJ.