Gold closed at $1,716 per ounce last Friday, almost $80 below the peak of $1,791.75 it reached three weeks ago. The drop was widely attributed to continuing global economic uncertainty and speculators taking profits – which means the experts have no idea what really happened. We don’t try to second-guess short-term fluctuations here at Casey Research, but instead keep our focus on the bigger picture.
In the greater scheme of things, a 4.2% decline is not a significant drop for gold; for a savvy investor, it’s another chance to buy bullion cheaper. We’re not alone in thinking that way: Reuters reports that gold holdings of metal-backed exchange-traded funds grew over this period. There are indications that Indians preparing for their festival season pushed demand higher as well.
An even better buying opportunity can be found with the gold equities. While gold was down 4.2% from October 4 to 26, gold stocks fell by 5.3% at the same time.
The difference isn’t all that big – so why do we think it’s important? First, the decrease would have been much greater if we’d cheated a bit and used the numbers as of two days earlier, underscoring yet again how volatile our market is. Second, the current decline in the sector is likely to be short-lived due to the traditionally stronger fall and winter season we’re entering. Third, the inherent leverage gold stocks carry over the price of the metal should deliver better-than-bullion returns when they rebound – a fact big investment funds have been taking advantage of for some time.
Gold’s rise drove many mining stocks much higher in August and September, but at present they are looking undervalued again. To see why, let’s examine their action over a longer time frame. In the chart below you can see how gold stocks have performed since the beginning of the year, as measured by the HUI (AMEX Gold Bugs Index).
The two highlighted areas are periods where the gold price was about the same. In February and October, gold peaked at $1,781 and $1,791, respectively, and then in both instances, declined to about $1,700. While gold was trading at nearly the same level in both cases, stocks are notably cheaper now than a year ago. Whether they are undervalued depends on the merits of each company, but as a group, the least we can say is that they are a better deal than they were a year ago.
Further, when resource stocks get cheaper in comparison to the underlying commodity – gold in this case – they tend to make up for the imbalance; their rebound is bigger. For example, if we look at the pattern in this year’s dips and recoveries, we see that gold stocks lose more in percentage terms than gold but also outpace the metal bouncing back.
As we have long said: gold stocks offer leverage to gold – in both directions.
Seasonality also matters: October has been historically the weakest month of the year for gold equities, usually followed by a surge in November. Combined, these factors signal that the current weakness is a great buying opportunity.
If you’re looking to buy the dips, this qualifies as one. This is the case for both gold and gold stocks.
When gold rebounds, the stocks will log bigger percentage gains. That’s been a consistent pattern throughout the bull market, so buying a tranche now will bring some attractive profits when the market turns around.
Key point: be picky. It goes without saying that not all stocks will perform equally. Some are poised to do better than others – and some a lot better.
It also happens to be election time in the US, and people will be “pulling the lever” for their preferred candidates soon. Our preference is for gold and gold stocks, and we’re voting with our pocketbooks.
By Alena Mikhan, Metals Team Researcher, Casey Research
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