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The Gold Stock Strategist analyzes leading junior gold producers and major gold mining companies.

Comments are welcomed!

Saturday, March 29, 2008

It's a Company, Not an Index

Yesterday, there was an interesting article written by Roland Watson entitled, "Gold and Silver Stocks vs. Bullion Investing " at Seeking Alpha lamenting the fact that precious metal mining stock prices have lagged bullion prices. He also argues that the price of silver stocks, and by extension gold stocks, depend on two factors:

(1) the stock market; and,
(2) the price of the precious metal.

Watson suggests that if both factors go up, precious metal mining stock prices go up. If one of the factors is going down, then silver/gold stocks go down.

It is a convincing article. The article makes it sound like holding gold stocks in the current environment is a "no-win" situation given stock market weakness and the recent sharp drop in the price of gold. To make matters seem even worse, the author even expects a sharper correction in the price of gold!

However, the author does provide a narrow relief scenario from what I call his overall "factor rule" thesis where gold stocks outperformed bullion. His relief scenario is counting on an anomaly in the 1980s when the "factors rule" didn't hold in 1983. The following is the chart he used to demonstrate his point. The light green line is the price of gold over the time period 1970-1983. The dark blue line is a gold stock index.

Here is the rub. The article uses a stock index, the Barron’s Gold Mining Index (BGMI) to make the point. I don't know anything about the BGMI or anything useful about technical analysis or charting of stocks or indexes. But I do know this. The companies I highlight on the Gold Stock Strategist are unique and should be less correlated with gold stock indexes than large cap gold mining stocks over the next year. The emerging producer junior gold miners are primarily event driven, not macro driven. Oh sure, the macro environment does have an effect on the long-run value of emerging producer junior gold miners. But the main event is that these companies are moving from NEGATIVE cash flow and earnings (like all mining explorers) to POSITIVE cash flow and earnings based on the commencement of PRODUCTION.

So when you read articles about "gold stocks" or "the price of gold" in reference to technical analysis or charting, it is important to remember the fundamental event that should drive junior gold miners highlighted on the Gold Stock Strategist--positive cash flow and earnings from new production. Such articles might be interesting, but they likely don't apply to these "event driven" stocks.

That doesn't mean these junior gold miners are a sure deal. There are still lots of risks--mill equipment can break down, additional resources may not prove up, labor shortages may delay production, management can make poor decisions, etc.. At the end of the day, junior gold miners are speculative plays. But the potential rewards are significant IMHO.


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