Gold Fundamentals As Strong As Ever

Includes: GLD, IAG, IAU, PGLC
by: Simon Trinh

Gold prices rose last week as the European Central Bank (ECB) cut its interest rate for the first time in 10 months to a record low 0.5 percent. The ECB's decision to lower rates affirmed the metal's inflation-hedge appeal a day after the Federal Reserve said it would continue its bond purchasing program. The ECB's decision was intended to ultimately spur growth in the recession-hit eurozone economy.

Gold fundamentals are as strong as ever

As mentioned in my previous article, gold had lost ~$225 per ounce between April 12 and 16 as some feared the potential withdrawal of Fed stimulus. Since then, strong demand for physical gold around the world has cut that drop by more than half.

In an exclusive CNBC interview, Jim Rickards of Tangent Capital says gold is transitioning from "weak hands to strong hands" (i.e. Comex traders and hedge funds selling to Russia, China and bullish investors around the world). This is good for the fundamental story of gold since, presumably, these "strong hands" will hold onto gold for the long-run (or until the global economy returns to the gold standard).

Here's the link to that interview: here

For those who are unfamiliar with the concept of the "gold standard," the proponents of the idea point to the creation of a Federal Gold Commission when Ronald Reagan took office in 1981. This was also during the time when double-digit inflation was crippling the U.S. economy. Today, the fear is that massive government spending and more than $1 trillion in monetary expansion by the Fed will spark a new wave of inflation and send the US back into the gold standard. In fact, just last September, the Republican Party proposed a return to the gold standard. So the possibility of a return to a fixed value currency isn't too far from the truth.

What we saw a few weeks ago (the major selloff of gold) was driven by the technicals, but the technicals can only dominate for so long (in the short run) until the fundamentals prevail. For me, the fundamental story of gold has not changed and will drive gold prices up. Even if 2013 ends up being a down year overall, gold prices will rebound rapidly on any signs of economic malaise. That is, regardless what the Federal Open Market Committee (FOMC) or the ECB's governing board says about central banking activities, the results will always be the same: whenever there is need the central bankers will do whatever it takes to stimulate global economic growth. This is apparent in the US and Japan, where the Bank of Japan (BOJ) began an historic expansion of its balance sheet. On Wednesday, the gold market responded when the FOMC reiterated its easy monetary policy, buying $85 billion in bonds each month to keep interest rates low and spur growth, and left open the possibility of further expansion.

The time to invest is now

For those sitting on the sidelines of this central bank induced madness that is beginning to look like a bubble, I urge you to invest because there are a lot of companies (good companies) that are trading at ridiculously low valuations and multiples. As I mentioned on my last article, now is a good time to look for mining companies that can survive the next 2-3 years because they will be the biggest winners.

The XAU Index of 30 major gold mining companies is trading at a discount to the price of gold that has risen more than 40% since the global recession in 2009. The chart below, courtesy of James Turk from Gold Money, shows how the miners have done compared to gold since 1988.

As we can clearly see, gold has outperformed the Dow and the miners during the current Bull Run. This is mostly attributable to rising costs associated with mining. Since the recession of 08/09, the miners have seriously underperformed and have gone to historic lows compared to gold. During the 90s when there was technically no bull market in gold and you could buy the mining companies in the XAU index for 6 to 10 grams of gold. Now you can buy the index for less than 3 grams of gold. The miners have never been this cheap relative to gold and I believe a combination of experience and prudent cost management can help the long-term viability of select miners.

Potential Investments

Two companies really stand out for me: Pershing Gold (NASDAQ:PGLC) and IAMGOLD (NYSE:IAG).

Pershing engages in the exploration and development of gold primarily in Nevada. Its main property is the Relief Canyon Mine in Northwestern Nevada, which is located near the legendary Carlin trend. Pershing owns all the claims surrounding the Relief Canyon which allows the company to take advantage of the gold available on the land. The latest drilling results showed 32.54 million tons at the reserve at an average grade of 0.017 oz/t which translates to ~550,000 ounces of gold.

IAMGOLD engages in the exploration and production of gold, silver, niobium and copper. It holds interest in five operating gold mines, one niobium mine and multiple exploration and development projects located in Africa and South America. This $114 million company has a massive treasury ($814 million in cash and equivalents as of December 31 2012), manageable debt levels and a strategic plan to expand productions. Its key asset (Rosebel mine) is one of the largest mines is Africa with an estimated mine life of over 20 years and produces nearly 400,000 ounces of gold annually.

At current prices physical gold demand will remain high, which, I believe, warrants an amazing buying opportunity since current reserves must be replaced with future high-quality production from miners. Moreover, if you look around the market, nearly everything except gold is trading at or near all-time highs. Investors need to acknowledge the opportunities that exist with the abundance of dirt cheap gold stocks and pounce on them like a true bull would.

Disclosure: I am long PGLC, IAG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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