Insights on Investing in Gold

His answer: Physical bullion remains a top play; the physical metal is a vehicle for profit, and will serve as an excellent hedge against inflation and the many problems that remain in both the global and domestic U.S. economies.

But gold miners are so cheap that they, too, deserve a look.

Well, at least some of them do.

"Bill, you'll see statements from some of Wall Street's big guns that gold miners are cheap right now," Peter told me during a telephone chat last week. "And that's true. They are cheap on a numerical [fundamental] basis, especially compared with historical valuations. But gold miners are cheap in another way, too - a way that Wall Street's either not telling us about, or just doesn't understand."

Needless to say, that last statement grabbed my attention. And I told him so.

Peter laughed, and then went on with his commentary.

"Over the last decade or so, the best of these companies have aggressively expanded their reserves. They've done so organically - that is, developed properties themselves. And they've done so by purchasing small development-stage, or production-stage players," Peter said. "Investors don't realize just how much it costs to add reserves - especially if a company is doing so by itself. That's particularly true today, with all the regulations and public protests boosting environmental and compliance costs."

Statistics Peter provided bear this out. In 1991, there were 11 gold discoveries. Twenty years later - in 2011 - there were three. And companies spent $8 billion looking for new strikes that same year.

"So you see, Bill, that the miners that already added reserves had tremendous foresight," Peter said. "Having spent a number of years just growing their reserves, all it will take to reap the payoff will be some event that kicks off a mania in gold prices. And we're not talking about longshot odds for that to happen. All you need is the "right' set of events, either domestically or globally, to cause gold prices to rise. When that happens, gold-mining stocks will be off to the races."

Gold prices have suffered of late because of a strong U.S. dollar. That surprising strength (in the face of the whole "fiscal-cliff" mess) stems from the fact that worries about Europe have transformed the dollar into a "safe-haven" investment.

Gold and the dollar are negatively correlated because gold is priced in dollars, but most of the buyers aren't in dollar-based economies. (Because these buyers are Swiss, Indian or Chinese, just to name a few, they look at the price of gold in Swiss francs, Indian rupees or Chinese renminbi. And if the U.S. dollar is strong, the price of gold in dollars is weak - even if the native currency price remains the same.)

So the rise we've seen in the dollar has been accompanied by a sell-off in gold.

Investing in Gold Stocks

Naturally, that sell-off in gold has affected gold stocks.

Over the past three months Newmont Mining Corp. (NYSE: NEM) is down about 21% and Barrick Gold Corp. (NYSE: ABX) is down about 20%, but the SPDR Gold Shares ETF is down only about 5%.

Looking ahead, the U.S. Federal Reserve's plan to continue printing money (and that of the European Central Bank (ECB), or the new stimulus plan we're likely to get from the Bank of Japan (BOJ) should be very good for gold.

And a jump in gold prices will be even better for gold miners.
The reason for that is called "leverage."

When gold prices jump, a gold-producer sees its earnings accelerate at a faster pace than the price of the actual metal.

I saw a hypothetical in a recent edition of USA Today that explains this perfectly.

For example, if you own a mine that can produce gold for $1,100 an ounce, but gold is trading at $1,200, you're making a profit of $100 an ounce.

But what if gold jumps from that $1,200 price level to, say, $1,500? That's a price increase of $300, or 25%. For the gold miner, however, profits have jumped from $100 to $300 - a 200% gain.

Two miners to consider are Newmont Mining Corp. (NYSE: NEM) and Barrick Gold Corp. (NYSE: ABX).

"One of the ones that I like is Newmont," Peter told me. "It has a very good dividend yield of nearly 3.2%. It's well-diversified geographically. The stock has gone sideways for a very long time and now the company is making a very concerted effort to keep its costs down."

Then there's the Toronto-based Barrick, the world's biggest gold producer.

"Barrick, like other miners, has seen that investors are not exactly thrilled with the performance of their shares," Peter said. "The reason for that is that the company spent a number of years just growing its reserves. But it did so by using its own stock as currency to buy the smaller companies that we talked about earlier. That was very dilutive."

But Barrick has suddenly gotten religion - of the shareholder variety. In June, it fired CEO Aaron Regent after less than four years on the job: Board members were apparently peeved that the company's share price didn't move during that period, despite the huge run-up in gold prices.

"Going forward, just from the signs or evidence that I've seen, the company has adopted a much more investor-attentive attitude - and the ouster of the CEO is just one bit of that evidence," Peter said. "The company is trying to focus on keeping its costs in line. And it's trying to produce the hell out of what it already has in the ground. The odds are high that we'll have a pretty good six to 12 months to come."

Barrick's 2.4% dividend isn't bad either - especially because of the current "zero-interest-rate-policy" (ZIRP) environment.

If you want the full lowdown on what's to come in the natural-resources sector - which we believe will have a big year in 2013 - take some time to see everything that Peter is looking at by clicking here.

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