Are Gold Stocks About to Turn?

Owning gold stocks over the last 12 months hasn’t exactly been a barrel of laughs.

Nearly every gold stock on the ASX has taken a big hit.

So-called ‘blue chips’ have been smashed. Newcrest (ASX:NCM) has fallen 36.7% in a year. Another Aussie heavyweight, Alacer Gold (ASX:AQG), has lost 43%. And midcap producers have fared even worse, like Ramelius (ASX:RMS) losing 66%.

Gold explorers have copped it even harder. The one-time market darling Ampella (ASX:AMX) has crashed a gut-wrenching 79.1% in the space of a year.

But with such drastic falls, gold stocks now look ridiculously cheap. And if I’m right, they look set to turn back up soon…

Of course, I’m not the first to make that claim.

Many, including myself, have had their fingers burnt trying to call the bottom for gold stocks this year.

But there are growing signs that the worst is now behind us.

For one thing, there has been a lot of corporate activity in the gold sector recently.

Silver Lake (ASX:SLR) made a bid for Integra (ASX:IGR) for $426 million. And St Barbara (ASX:SBR) is taking over Allied (ASX:ALD) for $556 million.

This mergers and acquisition action has been great to see, as it has stirred some interest in the gold sector. It also tells us that these big players see value at current prices. Management would generally try and avoid paying $556 million if they thought it would be cheaper in a few months. So seeing a few takeovers is a good warning that prices may be on their lows.

The technical charts are telling us a few positive things, too. The market vectors gold miners index (GDX), which tracks a wide basket of large gold stocks, seems to have found a floor at last. It bounced once in May, and again from a higher level last month. This sort of price action can be a good sign.

This GDX index is also testing the 50-day moving average (the blue line), which is another good signal. We’d need a few more months of price action to argue this is the start of a recovery, but the evidence is mounting.

There is a growing chorus in the marketplace calling the bottom of the market. The wind seems to be shifting with investor sentiment, too. When I was in Kalgoorlie last week for the annual Diggers and Dealers conference, most people I spoke to were excited about gold’s chances in the next 12 months.

A poll run by a company called Aggreko showed that 61% of those surveyed picked gold to be the ‘hottest commodity’ for the year ahead.Graphite was in second place, but that’s a story for another day.

Gold has got more attention in the media lately too. Just this morningBloomberg announced:

‘Billionaire investors George Soros and John Paulson increased their stakes in the biggest exchange- traded fund backed by gold as prices posted the largest quarterly drop since 2008.

‘Soros Fund Management more than doubled its investment in the SPDR Gold Trust to 884,400 shares as of June 30, compared with three months earlier, a U.S. Securities and Exchange Commission filing for second-quarter holdings showed yesterday. Paulson & Co. increased its holdings by 26 percent to 21.8 million shares.’

In my August issue I wrote the following to Diggers and Drillers readers:

‘After a flat 12 months, gold has fallen off many investors’ radars. At the start of August, gold was trading exactly where it was 12 months prior (both in US$ and A$ terms).

‘On the few occasions during gold’s 11-year bull market that gold has managed to tread water like this over a full 12 months, gold (in $US) then went on to gain an average of 33% over the following 12 months.

‘Mathematically, if gold (in US$) is to maintain its average annual return of around 17% per year, then a flat year needs to be followed by a ‘catch-up’ year of around double its typical annual gain, i.e. 33%.

‘The average annual gain over ten years for Australian dollar gold has been 10.7%. So if we saw a ‘catch up’ year in the next twelve months, from today’s price of A$1538, Australian dollar gold would reach A$1884.

‘Of course, this all assumes that gold is still in a bull market. After going nowhere for 12 months, many in the market, including me, have had their conviction tested at times.

‘However, the fact is that all the market forces that have driven the gold price this far are still in full effect: High market risk and geopolitical risk, central bank balance sheet expansion, negative real interest rates, record lows on AAA bonds, flat mine and scrap supply, net central bank buying…the list goes on.

‘Simply put – gold can’t hover forever in this market environment. And I suspect we are getting very close to a ‘catch-up year’.

With gold standing a fair chance of another leg up before the year ends, and gold stocks showing signs of life, I tipped a gold stock yesterday for the first time in 6 months.

With the market still a very dangerous place, I made sure to pick as low risk a stock as I could.

So I went for one that is derisked in every way possible. It’s in production, has low costs, has a tonne of cash, is paying a dividend and is based in a safe location.

There’s still plenty of excitement to it too, in terms of exploration upside and increasing production. I reckon readers could make 78% on this tip over a year. That would be a good win if everything pans out as I hope.

But when the market conditions are right, gold explorers can run even harder than producers like my latest tip. So if the next few months prove that the gold sector really is turning back up, then I might be game enough to tip a few gold explorers too.

Dr. Alex Cowie
Editor, Money Morning

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