Sunday, August 28, 2011

Gold miners about to breakout to new highs?

Gold stocks have been consolidating for the best part of 12 months, even as the price of the metal has moved around 40% higher from the January lows at around US$1300 (closing Friday at almost $1830).

Many of the Gold miners are still priced as if Gold was around $1100-1300 and it's going to be a wild ride if they start to price in higher Gold prices as the metal heads toward $2000 and beyond.

Cerro Resources (ASX: CJO) recently released an investors presentation in which they highlight the NPV of their Cerro del Gallo (Mexico) project, the figures are based on metal prices of: $US1,293Au/$US23.87Ag. It's companies like this whose share price will benefit from a higher average price in the metals. For example CJO is due to release a BFS in the 4th quarter of this year and the project economics are likely to be improved by the higher metal prices. Once the market wakes up to these undervalued companies they are likely to be re-rated.

Another company Argent Minerals (ASX: ARD) late last year was able to increase the size of their resource (at the Kempfield Silver Project) by reducing the cutoff grade due to a rising Silver price.

A rising price of Gold has the potential to multiply profits for high cost/low margin producers by a huge amount. For example take a low margin Gold producer who had total costs per ounce of $1200, they may have only been making $100 per ounce earlier this year (say $3m gross pofit per year if a 30koz pa producer), a move from a $1300 average price of Gold to $1600 has the potential to quadruple that companies profits (and share price/market cap).

The above are just some examples of how a rising price of Gold/Silver can benefit the related miners. Of course there are also many pitfalls to buying the miners and if buying into companies directly there is no guarantee that that your picks will perform as well as a Gold stock index. For that reason some who want to take advantage of the Gold miners may wish to buy into an index (such as the GDX ETF) rather than specific stocks. Unfortunately I have not seen an ETF that can be purchased on the Australian stock exchange. We have a Gold stock index (ASX:XGD), however I haven't come across any way to get direct exposure to it's price.

Both the HUI and GDX are consolidating toward the top of the range they have been trading within for the last 12 months and are looking prime for a breakout (although as I pointed out earlier, until we see the breakout there is risk the pattern plays out as a H&S top):


The GDXJ (similar to GDX, but an index of junior stocks) is trailing the performance of the above indices as the smaller and less developed companies are weighed down with the negative sentiment in the general stock market:


This is made obvious when comparing the GDX and GDXJ directly (see chart below). The GDX has out performed the juniors over the past 4 weeks during the recent astockalypse.

The junior stocks tend to out perform during the good times and under perform during the risky times.


The HUI:GOLD ratio (previously discussed in this post) is looking to slowly trend higher (higher highs, higher lows, see chart below) as the miners finally start to reflect the increase in the price of the metal. There is still a long way for them to go and if we return to valuations similar to that seen earlier in the year (HUI:GOLD @ .4) then we could be in for a quick 20-30% rally in the miners (assuming the price of Gold remains around the $1800-$1900 level) as they breakout of the current consolidation range and move higher.


The price of Gold has run hard over recent weeks. Those looking for exposure to precious metals are probably better looking to the stocks which are cheap compared with the metal and not largely stretched above the 50 and 200 moving averages as the metal is.

On Friday Bernanke made a speech at Jackson Hole (can be read in it's entirety here), the market was expecting QE3 and while they didn't get it implicitly Bernanke suggested that the tools at the Fed's disposal will be discussed in depth at an extended FOMC meeting in September:
In addition to refining our forward guidance, the Federal Reserve has a range of tools that could be used to provide additional monetary stimulus. We discussed the relative merits and costs of such tools at our August meeting. We will continue to consider those and other pertinent issues, including of course economic and financial developments, at our meeting in September, which has been scheduled for two days (the 20th and the 21st) instead of one to allow a fuller discussion. The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate to promote a stronger economic recovery in a context of price stability.
I think the market could look favorably on the wording from the speech and perhaps ease the current rout in stocks and allow the Gold stocks to catchup to the metal.

Starting this week I will be introducing a "fantasy portfolio" of Gold/Silver stocks. It will be similar in fashion to that 'The Speculator' from the Eureka report maintains, except it will predominantly be precious metal based stocks, rather than a mixture of industries. Keep an eye out for it as I will provide further details in the next couple of days. Immediate positions will be taken in the portfolio, with a view to increase them if we see a breakout to new highs in the miners. To keep updated with this portfolio I would recommend subscribing by email (free):

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  1. Fantastic post BB!

    I share many of the your views that the stock market will go up a bit now and that the gold miners will catch up a bit to reflect current PM prices.

    I bought some miners earlier today and will enjoy following the fantasy portfolio!

  2. Thanks Dave.

    Volatile times and Europe could easily throw us a curve ball, but if not then I think we will see a meltup or at least sideways action in the markets until mid September. Could provide an opportunity for the Gold stocks to stabilise and start breaking out to new highs... here's hoping!