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Gold Is The New Contrarian Play

Jul. 23, 2013 10:00 AM ET
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From 2002 to 2011, the price of gold increased by a factor of five - peaking at a record $1,909 per ounce.

It certainly won its share of fans in that period.

However, it's been on a downward slide since then, plunging below $1,300 per ounce. Now, suddenly, everyone seems to be bearish.

But the truth is, gold - for the first time in years - is actually a bargain.

Here's why…

Digging for Bargains

Fueled by capital from investment banks, the chief executives at many gold-mining companies invested in very low-quality gold mines, hoping that prices at the retail level would rise high enough to hide their mistakes. Well, they didn't, and what you see today is a gold-mining sector where stocks have imploded… and that's putting it mildly.

Most gold stocks are down by more than 60%, some even worse than that. But now, they've been beaten down so low that they've become bargains - a genuine contrarian play.

We've seen a major washout in the sector. Miners will be forced to shut down or "put on maintenance" mines that are unprofitable - something that will right the erroneous decisions made by management in the past decade. The market has a mechanism for righting even the most idiotic decisions by management, given time.

Indeed, share prices are already showing an interesting basing pattern, where they're no longer falling as hard or fast as they did when this selling began.

At current levels, they present a compelling opportunity for those willing to add to or initiate positions. The tumble we've seen in gold shares is similar to what we saw in the past for internet stocks and financial stocks. It'll take some time, maybe a couple of years or more, but the shares of quality mining shares will recover.

Who's Buying In?

You might also consider the SPDR Gold Trust ETF (GLD).

GLD has provided an interesting way for investors and institutions to buy or sell gold in real-time with a real-time impact. For the last 22 months, GLD has been seeing liquidations, and that culminated in a drop of more than $200 per ounce in just a couple of sessions.

Obviously, this makes the price of gold much less predictable. In fact, the conspiracy theorists point to GLD as the primary cause of the collapse for gold. Maybe. But the more interesting question is, "Who is buying while others are selling?"

The numbers show that the Chinese have bought more gold this year to date, than all of last year - as have central banks around the world.

For example, non-Western central banks have been increasing their holdings of gold at a very rapid pace, going from 6,300 metric tons in the first quarter of 2009 to more than 8,200 metric tons at the end of the first quarter of 2013.

That trend is likely to continue, as gold is trading at its biggest discount in two years - its recent rally notwithstanding.

If central banks are buying, it won't be long before retail investors realize that they're being left behind.

So gold may be down, but it's not out. To the contrary, it could be about to make a major comeback.

And "the chase" continues,

Karim Rahemtulla

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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