Being a follower of gold and gold stocks, I can tell you they are two different breeds altogether. Just because gold goes up doesn’t mean that gold stocks also will.
You must remember there are other factors that go into building a gold company aside from the metal’s actual price moving higher.
The company must be able to keep its costs in line and meet production goals. It also must replace the gold it is producing by increasing reserves.
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However, if a company can do these things, it can actually outperform gold because its profit margins increase when gold climbs in price.
However, many also use gold stocks as trading vehicles — it tends to be more hot money than the physical market itself: more hedge funds, more short-term traders.
For this reason, gold stocks can often outperform the metal.
A gauge I use to look at gold stocks and how they are valued relative to gold is the Amex Gold Bugs Index (HUI) to gold ratio. This is a percentage of a value of the HUI is trading when compared to gold.
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The ratio usually trades between 30 percent and 60 percent. This means that when, for example, gold is trading at $1,500 and the HUI at 900, the ratio is 60 percent and gold stocks are expensive compared to the metal. You want to sell your gold stocks at that level. When the ratio is 30 percent, gold stocks are very cheap. For example, at the 2008 financial crisis low in gold stocks, the HUI-to-gold ratio hit 20.5 percent.
At the moment, this ratio is 34 percent. This is the lowest since early 2010, which was an important low for gold stocks.
By more conventional measures in my more than 10 years of trading gold stocks, I have never seen them this cheap. Gold stocks traditional carry higher multiples because of the high cost of operation.
Traditionally, they trade in the 30 to 40 times earnings range. Many companies today are trading in the mid-teens or even lower. I have never seen so many cheap precious-metals companies. They now appear to be on sale.
You buy when things are cheap. Right now, gold stocks are cheap.
About the Author: David Skarica
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