You Should Pile Into This Sector Immediately

by: Shmulik Karpf

There is a strange correlation between the stocks of gold companies and gold, the metal.

Gold is perceived as a 'safe haven' asset. An asset whose value is maintained throughout turbulent times in the markets. Most importantly, gold cannot be 'printed' over and hence serves as the ultimate protection from massive money printing and inflation.

In the chart below, you can see the movements of the SPY (orange line), GLD (an ETF which tracks the price of gold, in blue) and GDX (green line, an ETF which tracks the performance of gold companies).

As you can see, GLD and GDX normally move in tandem. It only makes sense that higher prices for the golden metal (more expensive GLD) will transform into higher stock prices (more expensive GDX). But this strong correlation was violated around 2 months ago. Since then, GLD is relatively flat while GDX is plummeting. This seems even more out of context while taking into consideration the SPY, which is abnormally flat during this period.

In short, what we are currently witnessing is an exceptional weakness in the GDX that both GLD and SPY succeeded in avoiding. Naturally, this situation is unsustainable. There is no reason why gold stocks should be hit that hard, that fast. This scenario will correct itself.

The beaten sector

Nowadays, the sector of gold companies is bitten, battered and thrown to the sidelines, up to a point of complete devastation. Current valuations reflect an utter disaster. This is how this sector looks like today:

Companies/Metrics forw. P/E Price/Book 52 week High to Low Current Price
Barrick Gold (NYSE:ABX) 7.2 1.74 $34.8 - $56 $41
GoldCorp In. (NYSE:GG) 12 1.48 $32 - $56 $39.4
Kinross Gold (NYSE:KGC) 7.6 0.78 $7- $18.25 $8.5
New Gold Inc. (NYSEMKT:NGD) 13.5 1.92 $7.13- $14.15 $9.48
IAMGold Corp. (NYSE:IAG) 7.3 1.22 $9.20- $23.88 $11.7
Nova Gold (NYSEMKT:NG) N/A 3.2 $4.98-$11.77 $6.37
Almaden Minerals (NYSEMKT:AAU) N/A 2.5 $1.69- $4.67 $2.16
Franco Corp. (NYSE:FNV) 27 2.13 $34-$48.25 $45.34
AuRico Gold (NYSE:AUQ) 8.4 0.97 $6.69- $14.17 $7.75
Tanzanyan royalty (NYSEMKT:TRX) N/A 8.39 $1.56- $7.04 $4.17

Although some of these companies do not scream a "buy", the majority of them are very, very cheap. Barrick Gold, for example, should not be trading anywhere around current valuations.

The opportunity

The stock prices of gold companies have just begun to rebound from their lows. It was particularly apparent in last Friday's trading when the major indices lost more than 2.5% while all the companies above gained more than 5% on average.

Look at the chart of ABX for example. The company very recently rebounded from its recent bottom of $35. Buying before a bottom was formed could be very lucrative, but it is a very risky endeavor. On the other hand, buying after a bottom (or a double bottom) was formed is a winner's game.

My Recommendation

Do not let the run on gold stocks escape you. You can either invest in any specific company from the list above or simply bet on the whole sector through the GDX ETF. Buy GDX up to $50. Place your stop loss at $42 and take profits at $66.

If you'd like to add more risk with greater potential for profits, you can either buy at the money call options on the GDX maturing 3 months from now, or buy the (JGDX), which is an ETF that tracks junior mining companies, You are likely to make money either way.

Disclosure: I am long GDX.