Five Bullish Forces for Gold

Sean Brodrick
by Sean Brodrick, Resource Strategist

Earlier this week, I was at The Oxford Club's Private Wealth Seminar in Ojai, Calif.

It’s the same place Jimmy Kimmel got married at over the weekend. Apparently

I just missed catching a glimpse of Jennifer Aniston and Ellen DeGeneres.

But I say The Oxford Club brought the real stars. I spent the last few days

listening to...

  • Alexander Green talk about the methodology behind the Gone Fishin’ Portfolio.
  • Steve McDonald deliver the skinny on fat bond profits.
  • Dr. Scott Brown explain his trade management system in depth and with rock-solid examples. I loved his historical stories, too!
  • Marc Lichtenfeld give his scoops on dividends.

And much more. It was great stuff! Interesting... and worth every minute of my time.

But at the same time, I was itching to start making some deep-value picks in miners, because dang, it sure looks like gold is ready to rally. If gold were a rocket, it would be on the launch pad with smoke coming out of the engine.

Here are five reasons I’m currently bullish on gold:

1. Ben Bernanke puts on a happy face for gold.

Fed Chairman Bernanke lit a fire under gold (and other commodities) last week when he reminded the markets that the U.S. needs “highly accommodative monetary policy for the foreseeable future.” What’s more, minutes from the Fed’s June policy meeting showed many officials wanted a stronger labor market before tapering bond purchases.

What does that mean? While the market remains worried that the Fed will slow, and eventually end, its purchases of bonds and mortgage-backed securities (currently at $85 billion a month), the chairman’s remarks last week suggested that he intends to keep the Fed’s money sluices open for a while longer.

That news helped send gold up more than 5% last week.

This week, Bernanke said that the Fed’s bond purchases “are by no means on a preset course” and will depend on the economy’s performance. This sent gold and silver into more gyrations. But it’s still up from last week, so overall, gold bulls are happy.

Sometimes the Fed shows gold its scary face ... sometimes we get the friendly face. For now, it’s a boost for gold.

2. South Africa’s mining companies and unions are at loggerheads.

Seven gold companies are trying to hash out a deal with four unions. The companies are offering raises of about 4%. The unions want raises of between 60% and 100% just for entry-level workers alone.

I don’t see much common ground between them. I think that the likeliest path is for South African labor relations to spiral even lower. Most of those mines are losing money even with the current labor agreements.

South Africa is the fifth-biggest gold producing nation in the world. It produced 170 metric tonnes of gold in 2012. If South Africa can’t solve its labor troubles, a big source of global gold supply is going to dry up, and that should put upward pressure on prices.

3. Junior miners are undervalued.

Stockhouse Ticker Trax keeps a running tally of valuations in the junior miner/explorer space. These are companies that have actual resources, not just real estate. Yet they’re being valued like they’re sitting on piles of trash, not gold ore.

Ticker Trax writes:

“Of the 50 we track on the TSX and TSX Venture (with a minimum 1 million ounces measured and indicated), the values came close to $11 per gold ounce last week. They have since recovered from that low but currently sit near $12.40 per ounce (using our risked reserve approach that has proven accurate since March of 2011).”

You know what that tells me? There’s no optimism in this industry - zip, nada, none. And if you’re a contrarian, that’s a great time to start looking for bargains.

4. Either prices go up or miners shut down.

The world’s leading gold miner, Barrick Gold, believes that the entire industry’s all-in sustaining costs of production are now $1,200 an ounce, up from $300 in 2002. With the gold price at $1,280 recently, the gold industry as a whole is only marginally profitable at best.

It gets worse. SBG Securities just crunched the latest numbers from the World Gold Council, and says the average all-in cost for the world’s top five global gold mining companies was $1,467 per ounce in the first quarter of this year.

And hey, have you noticed how the price of oil is going higher? Guess what miners use a lot of? Gasoline and diesel. Their costs are likely to go higher still.

Miners can only work through their cash for so long. If prices don’t go up, they’ll shut down mines that don’t work at present prices and concentrate on those that do. Do I expect that to happen? Not really, because the very prospect of it should be factored into the price of gold, sending it to $1,400 by the end of this year.

5. Banks are looking for a rebound.

Germany’s Commerzbank forecast that gold would rise to $1,300 by the fourth quarter and $1,400 by the first quarter of 2014.

What’s more, Comerzbank said that a rebound for gold would help silver get to $21 in the fourth quarter and $23 in the first quarter next year. That’s important, because the average break-even cost of production across the silver industry is about $23.

Now, remember that gold forecasts are about as good as any market forecast - cloudy at best. The more interesting thing to me is that we’re seeing a big bank start raising its gold price forecast again. For many months, forecasts have only gone in the other direction.

Sentiment is very important. Sentiment is what has driven ETFs that own physical gold to sell their stockpiles of the metal at the worst possible time. A shift in sentiment could change the whole ballgame.

Hurdles Still Remain

Not everything is bullish. There are still factors that make investors wary of gold...

Gold ETF selling. The selling of gold by ETFs has slowed, but it could pick up again. In my opinion, this is is the most bearish force on the market right now. Of course, if funds start buying gold again, that would be rocket fuel for gold prices.

Inflation Is Still Tame. The latest (June) PPI data showed core PPI inflation of just 0.2% year over year. But headline PPI was higher at 2.5% - and up from 1.8% in May - so maybe we’re starting to see the first hints of inflation. It’s still low inflation, so don’t get too excited. But it could affect the third thing...

Sentiment Is Awful. No doubt about it, most investors hate gold, silver and mining stocks. On the other hand, that’s a great time to look for bargains. When sentiment finally turns, bargain-hunters of quality stocks will be richly rewarded.

If you’re doing this on your own, be careful, and be aware that even the most promising rockets can crash and burn. On the other hand, riding that rocket is the only way to get to the stars.

Good investing,

Sean

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