As investors looking for leveraged exposure to gold prices we tend to favor unhedged gold mining companies such as those listed on the HUI, which is the AMEX Gold BUGS (Basket of Unhedged Gold Stocks) Index. At the start of 2011 this Index stood at 575, at the start of 2012 it stood at 500 and this year it started at 440. So we can see that the last two years have been negative in terms of returns on an investment in this sector. There are always exceptions to the rule but in the main gold stock prices have been heading south as demonstrated on the chart below:
During this torrid period for the stocks we remained on the sidelines preferring the accumulation of the physical metal and the occasional foray into the options market, a strategy that has served us well. However, after two years in the doldrums we must now wrestle with the possibility that the mining stocks could be on the launch pad and ready to break out.
There are a myriad of factors that have a bearing on the fortunes of the mining sector with one of the most important being the global increase in paper money. Every time the printing presses produce more paper money they dilute the value of the existing currency which in turn usually adds to inflationary pressures. As inflation rises the need to own gold increases exerting upward pressure on gold prices, supposedly benefiting the producers along the way. However, inflationary pressures have remained relatively subdued, if the official stats are to be believed, capping gold’s progress and taking the shine off the mining sector. Gold’s inverse relationship with US$ remains intact, but the dollar is having difficulty going lower as governments around the world dilute their own currencies in this on-going race to bottom.
Among the other factors affecting this sector are the US Debt ceiling debacle which will no doubt have the talking heads dramatizing the situation all they can, but as we saw with the fiscal cliff not much will change. The news that Germany wishes to repatriate gold reserves from France and USA is also causing alarm bells to ring, but we suspect that this transition will be managed for mutual benefit of those involved.
Investors are usually seeking a capital gain on their investment and occasionally when a capital gain is not on the cards, some investors will invest on the basis of a good stock dividend. Unfortunately dividends from mining companies vary from low to nonexistent which only serves to deter many investors. It gets worse when we see the management of profitable companies continually reinvesting their profits into the acquisition of the juniors. We all appreciate the need to fill the pipeline in terms of future supply, but if this process is endless then our investment serves only to keep those companies in full employment, so we hope that this article serves as a wakeup call for them to do more for their embattled supporters.
In conclusion we are of the opinion that both gold and silver prices will rise this year and finish a lot higher than they are now. For gold producers it will be a different story with the quality stocks making substantial progress. However, this is not a situation whereby all the boats rise on a rising tide, for the majority of the companies in this sector there will be very little support. Investors are choosey and will need to be more so and do their due diligence more than ever before, if they are to turn a profit in this market. The low hanging fruit has indeed been harvested so we are entering the ‘hard work’ phase of investing in this sector.
Take heed, this is not a time for a nonchalant approach to investing, that hot stock today could well be tomorrows dog and not one that you want in your portfolio. Find the time, do the work, choose your stocks very carefully and then layer into them gently.
For us it is slightly different as we already have a core position and now our strategy will be to identify those stocks that have been severely oversold and are due to bounce back. Within our small team, just the four of us, we refer to this as the ‘catch the wave’ philosophy whereby a number of good quality stocks will be bought and sold during 2013 hopefully generating decent profits for our portfolio.
We wish you all a successful and profitable year ahead.
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