Gold beat a hasty retreat after setting records by trading north of $840 an ounce earlier this month, but don't be fooled.
It's only taking a breather before it climbs past $1,000.
So this is a good time to get exposure to the metal. I'd buy shares of four well-positioned gold producers favored by two of the top-performing money managers in the sector, which I'll detail in a moment.
Or to get more diversified exposure, you could simply own the mutual funds of these two managers: Thomas Winmill of the Midas Fund (MIDSX) and Frank Holmes of the U.S. Global Investors World Precious Minerals Fund. Winmill's fund is the No. 1-ranked fund for total returns this year, and Holmes' fund topped the charts last year.
Here are four reasons why these two gold bugs and other experts think the metal could see fresh highs soon.
No. 1: The dollar's in trouble
For the next move up in gold, you can thank the Fed. That's because the Fed is going to keep cutting interest rates, which will make investors sell dollars to chase better returns outside the U.S. Investors holding assets in dollars see this coming, so they too will be dumping dollars to avoid the carnage and get their money into something more stable -- including gold.
"The biggest buying pressure for gold is for use as an alternative currency," says Winmill, whose Midas Fund is up 38.5% annualized over the past three years, or 12.7 percentage points better than its category. "It won't take much diversification out of the dollar for gold to go up." History backs this view. Over the past 30 years, the correlation between gold and the U.S. dollar has been greater than 70%, according to CIBC World Markets analyst Barry Cooper.
Is it a sure thing that the Fed will continue cutting rates at its Dec. 11 meeting? No. But that's how the smart money is betting. Wall Street trading suggests bond investors were giving 100% odds of a rate cut when the Fed meets next month, according to Ed Yardeni of Yardeni Research.
It's easy to see why bond investors might take this view. There are plenty of reasons to think inflation won't be much of a threat, giving the Fed the leeway to cut interest rates. The credit crunch is getting worse, and it's likely to begin taking its toll on economic growth soon, says Citigroup economist Robert DiClemente. In a weakening economy, it's harder for producers to raise prices. Consumer spending growth came in at just 0.1% in October, by one measure. In this kind of environment, it will be tough to get price increases on consumer products, says DiClemente.
If the risk of inflation really does subside, that will make it easier for the Fed to cut interest rates without worrying it will stimulate so much growth that prices go out of control.
Even if the Fed doesn’t cut rates Dec. 11, credit market woes and problems in the housing sector that threaten the economy will leave investors thinking a rate cut is still coming. That will continue to put downward pressure on the dollar.
No. 2: Gold production lags demand
While investors chase gold to get into something more stable than the dollar, producers aren't keeping up. Gold production was down 3% last year, and it was flat in the most recent quarter.
Mining companies are spending more on new production -- especially in China and Russia. But that's not offsetting dwindling output from mature mines in places like Nevada, Australia and South Africa, says Citigroup analyst John Hill. Barrick Gold recently told analysts it thinks gold production will fall short of market expectations by 10% to 15% over the next three to five years. True, central banks hold a lot of gold. But they are bound by an agreement that imposes limits on sales.
No. 3: Gold producers are buying gold
Traditionally, gold producers have sold gold for delivery at some point in the future, to offset the risk that prices may decline between now and then. Not so much anymore. Apparently sensing more gains ahead for gold, producers are unwinding their hedges.
To get out of hedges, they have to buy gold, which adds to demand. There's more to come, predicts Oscar Cabrera of Goldman Sachs Group. He says both AngloGold Ashanti and Barrick have been "stung" by mounting losses on big gold hedge positions. "We expect these entrenched positions will ultimately be unwound, providing further catalysts for gold," says Cabrera. |
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No. 4: Gold follows oil
Historically, gold prices track the price of oil, in part because as oil producers earn more money, they buy gold for diversification, says U.S. Global Investors' Holmes, whose World Precious Minerals Fund topped its category last year with a 52% return.
Gold tends to trade for 10 times the average price of oil over any two-month period. Since oil has recently traded in the mid-$90 range, that suggests gold could reach $950, not far from $1,000.
4 gold mining plays
Given how much the price of gold has gone up, it's now crucial to be cautious on companies with assets that might get taken over by governments that negotiated unfavorable mining concessions years ago, when gold was much cheaper.
Now, with gold prices so much higher, these governments are under pressure to take back the mines -- or use the threat of expropriation to void contracts and get better terms, says Winmill. "A lot of those deals negotiated six or seven years ago when gold was at rock bottom and countries were desperate to raise capital, are being renegotiated," he says.
To dodge this risk, he suggests sticking with mining companies with assets in countries whose legal systems make it harder to wriggle out of contracts. He puts the U.S., Canada, Mexico, Finland, Sweden and Australia on this list.
Next, you want to go with mining companies that have huge, undeveloped deposits that will rise in value as gold crosses over $1,000. "There is scarcity value. As gold prices go up, the value of these deposits can go up enormously," he says.
Winmill puts NovaGold Resources at the top of the list for both criteria. It owns the rights to a huge gold deposit in Alaska called Donlin Creek, which could hold as much as 33 million ounces of gold. "That is one of the biggest deposits in the world, and the biggest in all of the politically safe countries in the world," says Winmill.
Donlin Creek also contains big copper deposits. NovaGold Resources has a joint venture agreement with Barrick Gold to develop Donlin Creek, which adds credibility to its story. NovaGold has three or four other significant gold fields in Alaska and British Columbia.
"The company has successfully pursued a strategy of tying up large deposits when commodity prices were low and is now bringing these toward production," says Citigroup's Hill, who has a buy rating on the stock. Even before that happens, NovaGold Resources could get taken over because its holdings are so attractive, says Winmill.
Winmill also likes Northern Dynasty Minerals, which has a huge gold, copper and molybdenum project in Alaska called Pebble. The chairman of Northern Dynasty is Robert Dickinson of Hunter Dickinson, a private Vancouver, British Columbia, mining company that has a good record for finding developing precious metal assets, says Winmill.
Northern Dynasty has a joint venture with Anglo American to develop Pebble. And the mining company Rio Tinto has a 19% stake in Northern Dynasty. Close ties with both of those companies suggest either one could buy out Northern Dynasty to get full control of its assets, believes Winmill. "My instinct is someone is going to acquire the company, and it would be good fit with Anglo American and Rio Tinto," he says.
Raymond James Financial analyst Tom Meyer describes Northern Dynasty as an "ideal way" to get exposure to precious metals, in part because its shares look cheap compared with peers.
Two favorite gold mining picks of U.S. Global Investors' Holmes are Yamana Gold and Goldcorp. Yamana Gold operates several mines in Brazil. The biggest is a cash cow called Chapada where production is growing so fast that the mine helped gold production at Yamana increase by 48% in the past quarter. The company also has several exploration projects in Brazil, Argentina and Nicaragua which it believes will more than double its gold production to 2.2 million ounces a year in five years. Yamana Gold recently agreed to purchase Meridian Gold at a price that was low enough so that the merger will add substantially to earnings over time, says Holmes.
Holmes favors Goldcorp because it has stakes in big gold and copper mining projects in Canada and Argentina whose growth contributed to 28% production growth at the company in the last quarter. Goldcorp also has about the lowest costs among the major gold producers. It recently forecast that it will produce gold at an average cost of $150 per ounce in 2007, once credits for the sale of copper and other mining byproducts are factored in. Holmes also believes Goldcorp has a lot of upside potential because it is developing a large gold, silver and zinc project in Mexico called Peñasquito
At the time of publication, Michael Brush did not own or control shares of companies mentioned in this column. |
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