Gold is flirting
with $1,000 an ounce right now and there are many
supply, demand, psychological and monetary reasons
for this. Commodities in general have been moving
in a near vertical fashion for the last 3 to 6 months
and, even though there most certainly is aggressive
speculation contributing to this latest move, the
underlying fundamentals and macro economic reasons
for a continuation of this move are present.
When gold was
at $650 an ounce in August of 2007, the Bears were
calling for a collapse to the high $400’s as
the run to $650 was ‘over-extended’. This
did not happen. Why not? Gold was the world’s
first currency and it may very well be the last. The
old saying that ‘Money does not grow on trees’
is absolutely wrong. Paper money, or fiat currency,
is printed on paper and therefore literally does grow
on trees. If this paper money falls off the trees
faster than we dig up the gold, the amount of paper
you trade for gold increases. In 2007 Australia increased
its money supply by 20.7%, Brazil +17%, Canada +12.9%,
China +18.5%, The Euro +12.3%, Hong Kong +31.5%, India
+21.5% and the USA +15.8% - a 47 year high. Thats
a whole lot more paper falling off those trees.
As the hot market
these days are commodities, and assuming the commodity
you are looking to get into is gold, I have come up
with the following ‘Seven Golden Rules’
to help guide you towards picking the right gold stock;
1) Location,
Location, Location
Where are they
digging for the gold? I learned the value of this
lesson back in 2006 when I was invested in Ivanhoe
Mines (NYSE: IVN). The fundamentals, valuation and
chart all looked good to me and I thought I had a
winner, so I bought in. The stock moved up nicely
and all was happy and joyous, until the Government
of Mongolia decided that the proper rate of taxation
on the foreign owned miner needed to be raised to
as much as 70% of profits. The stock plummeted and
I learned to pay attention to Rule #1.
2) He who has the Army makes
the Rules
Crystallex International
(AMEX: KRY), a Venezuelan mining concern has great
potential and spiked on good news in April of 2006.
I got in, made good money and got out after just a
few days. A few days after that Populist President
and Socialist Hugo Chavez started making noise about
nationalizing the mine. I barely avoided this nightmare
of the boogeyman stealing my gold, and sold my position
near all time highs at $6.10. At last look the stock
was tradingbelow $2.50
while gold has been going nowhere but up. KRY has
made those that still own it cry.
3) How Deep does a Gold-digger
Dig if a Gold-digger does Dig Gold?
This is all about
the costs per ounce of gold mined. As gold can be
found lying on the ground or three miles deep, the
amount of digging that needs to be done determines
the cost of each ounce of gold mined. The largest
gold mines in the world are in South Africa and run
as deep as two to three miles down. These mines need
to be air-conditioned, elevator accessed and it gets
very expensive to lug one of the heaviest metals in
the earth, as well as a lot of dirt and rock, up to
the surface. Also, copper is usually found in geologic
formations that produce gold. If a large amount of
copper is found along with the gold, the copper is
also sold thereby increasing the profit of the Gold-digger.
All that glitters is not gold, but if it is a little
duller in shine and makes for good plumbing, even
more profit flows from the mine.
4) Hedge Hogs
A few years ago
most all the gold mining companies started unwinding
and buying in all their future hedging contracts.
As I would think the people that knew the most about
the gold industry would be those working in the gold
industry, this was the strongest signal that a run
in the price of gold was coming. Most of the miners
out there are no longer hedged or hedged only in small
amounts, so this rule is least important at this point
in time. Avoid the more hedged companies. If you start
to see companies increasing their hedging this could
be an early signal the top in the price of gold is
near. If the miners stay 'naked' as far as futures
contracts are concerned, gold is going higher.
5) As Long as there is Life
there is Hope
Mines can die
out and be dug dry. The quarterly and yearly statements
of mining companies contain legally defined estimates
of ‘proven’ and ‘probable’
reserves. As gold is basically money in the ground,
the more of it they have found, and/or think they
have found, the more money they are worth now in potential
dollars and in the future in actual profit dollars.
In this respect the gold companies are very similar
to oil companies. Northgate Minerals (AMEX: NXG) has
a great P/E to growth ratio and when compared to other
mining companies looks fantastic fundamentally. The
problem with this company is that they only have 3
mines. In other words, they only have so much gold.
The gold is there and they will dig out some every
year, but if a currently mined vein runs dry, and
they have to start a different dig to get to another
vein that could mean less gold production that quarter
and an earnings miss. We hate earnings misses right?
The only way this type of company makes more money
is if the price of gold goes up, otherwise their earnings
will top out and that means no more growth other than
that attributed to the possible growth in the price
of gold. I owned this mine for awhile on fundamentals
alone, finally sold it, and it is still going sideways,
and sideways, and sideways…
6) Variety is the Spice of
Life
Having multiple
mines diversifies a company across the risks of a
mine running dry, caving in, electricity supply disruptions,
flooding, environmental concerns, etc… The more
mines the better. See Rule 5 and NXG.
7) Knowledge is Power
Finding gold,
mining gold and operating a company that is basically
a hole in the ground is a surprisingly complicated
operation. Proven and experienced management with
a long track record of beating their earnings number
is as important here as in any other industry. As
the price of gold heads higher companies across the
globe are digging and digging more furiously for it.
This has created a serious shortage of qualified and
experienced professionals in geology, metallurgy,
exploration and logistics. Experienced management
teams who know the top professionals and know the
value of retaining this brain power will build, retain
and operate better teams.
Once you find
a company that conforms to these Seven Golden Rules,
you can then move on to evaluating them like any other
stock according to their relative valuations, growth
potential and chart patterns. So put your Levi's on,
grab a pan, a donkey and act cranky and go strike
gold!
After watching
many segments about the history of gold strikes in
the United States, it was hillarious to find out how
many miners struck gold, walked into town and the
nearest saloon, plopped down a nugget for some whiskey
and subsequently got shot or claim jumped about 15
minutes later. I am pretty sure that if you find a
good gold company and tell a friend or two about it,
you are not going to get shot or mugged. Happy Hunting!
Coming soon
to the best Financial Blog Site Ever - My favorite
gold company and why!
~ Robert Perrego
2/28/2008 10:05 PM
Update - March 2, 2008
Saturday March 1st saw the highest
one day death toll in Palestine - 61 dead - since
the beginning of the second intifada.
Hugo Chavez on Sunday sent 10 armored
tank divisions to Venezuela's border with Colombia
and both sides have recalled their ambassadors.
More geo-political tensions means
gold goes higher.
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