 Gold Stocks 2006
Scott Wright
Zeal LLC
Dec 30, 2005
As 2005 comes to a close, the
bull market in gold is galloping forward into the new year with
unrelenting strength. Within the last month gold broke $500 for
the first time in 18 years and has peaked a 24-year nominal high.
There is no denying we are in the midst of a major secular bull
market in the Ancient Metal of Kings. Even with this impressive
gold bull, word is just starting to spread to the everyday investor.
With gold shattering multi-decade
highs, the financial media has been forced by virtue to cover
this gold extravaganza exposing it to the investing public. Unfortunately
many mainstream analysts attribute gold's recent run as a hedge
on building inflation fears and tend to exude a bearish outlook
on its future sustainability.
But under the surface of this
bull market lays a rock-solid foundation and stock investors
and speculators should still have ample opportunity to capture
legendary gains going forward. Inflation fears tend to be a popular
attribute but gold's run lies on core economic fundamentals
that mold the base of its foundation.
In addition to its timeless
fundamentals, at Zeal we have long discussed gold's
three bull-market stages. Each stage has historically produced
increasingly better gains and it appears as though we are only
just in the beginning part of the second stage! In the first
stage gold has risen on good part due to the weakness of the
US dollar, masking it as a US-only gold rally. Nevertheless a
huge rally it has been with awesome results for stock investors
and speculators who were positioned in companies that mine and
explore for this precious metal.
At Zeal we've been recommending
these stocks to our newsletter
subscribers since the very beginning of this gold bull and have
been blessed with tremendous gains. Many of the stocks we have
recommended in the past and will recommend in the future happen
to comprise the venerable HUI gold-stock index. The HUI consists
of 15 of some of the best publicly traded gold miners in the
world and is up 653% since the beginning of this bull market!
This is just an incredible
gain and has obviously been one of the best performing stock
market indexes in recent years. But one may wonder with such
astonishing gains if it is too late for investors to get a piece
of the action. We think not, in fact, we believe there is still
a long way to go before this gold bull has run its course and
that the best is yet to come.
Much to the delight of gold
bulls everywhere, earlier this year gold appeared to decouple
from its Stage One trend of having an inverse relationship with
the dollar. In these last few years the devaluation of the dollar,
long considered the world's reserve currency, was a useful and
fairly accurate trading tool for the flowing and ebbing of gold
in its upward trend. It appears now as though gold has divorced
from its dollar relationship and is on its own two feet courting
the world financial markets.
In the last six months gold
has risen in all major global
currencies simultaneously and has appeared to move into Stage Two
of its bull market. In Stage Two gold prices are expected to
rise based on a sharp increase in global investment demand and
break away from the dominant global currency. Stage Two gains
should also vastly exceed Stage One's as investors around the
world pour more capital into not only physical gold, but the
investment vehicles that are involved in the physical storage
and extraction of it.
So as capital pours into gold
upon this renewed global lust for the yellow metal, there will
be many opportunities for investors and speculators. Gold stocks
have been and will continue to be the market darlings of this
bull run. Gold itself is up 108% bull to date but gold stocks
measured by the HUI, which is considered the premier gold-stock
index and serves as our best proxy for the timing of trades,
are up over 600% on average.
Even though the HUI has risen
so fast in just four short years it has still not garnered much
attention from the greater investment community. Interestingly,
the total market capitalization of all 15 companies in the HUI,
combined, is less than 25% of Microsoft alone. Needless to say,
gold stocks have thus far been trading among a small group of
investors and have not yet begun to get global and institutional
attention.
When this does happen the capital
flooding in to buy these shares should drive up gold stocks to
levels never seen before and score legendary gains for those
that are well positioned before the releasing of the flood gates.
Once again the HUI is our flagship barometer for trading gold
stocks. Not only is it important as an elite gold stock index,
but its usefulness in timing and formulating many of our gold
stock technical trading
signals is priceless. Because of this it is worth a closer
look at the fundamentals of the HUI's components so we may see
how they truly reflect on the global gold industry.
One reason we like the HUI
as opposed to other gold-stock indexes is demonstrated above
by the way its gains outpace those of its underlying commodity,
known as leverage.
The gold miners that comprise this index are able to achieve
a positive leverage to rising gold by keeping their hedge books
at a minimum. The mining companies in the HUI are bullish on
the price of gold and want maximum exposure to what they can
sell it for on the open market, thus directly increasing their
profits.
There are many other fundamental
reasons why the HUI represents a valid leading indicator for
gold-stock investing. As mentioned, the HUI is comprised of some
of the biggest and best global gold miners. And in order to truly
examine the HUI and pin its individual components up against
the global gold market, I find it best to dig from within. I
pulled the financial statements from the last ten years for each
of the 15 HUI components in order to gather key aggregate data
that will help us with our examination.
First we find that in 2004
combined HUI gold production totaled nearly 21 million ounces.
According to the United States Geological Survey (USGS), global
gold mine production in 2004 totaled 79 million ounces. This
places the HUI, with a combined market capitalization of only
$67 billion, as providing the world with over one-quarter of
its mined gold supply. This alone showcases the global strength
of the HUI and should be case enough for its continued surge.
And just like any precious
metal or energy commodity, gold as a resource is finite. This
finite resource is slowly being depleted in order to maintain
its growing demand. For various reasons it is becoming increasingly
difficult to discover and develop gold deposits which has led
to today's economic imbalance. In order for miners to produce
gold and help supply keep up with demand, there is constant pressure
to continually renew their reserve base.
Gold reserves are defined as
economically mineable minerals that exist in operational, developed
or advanced exploration projects and are frequently calculated
by each miner. Reserves are revealed through the results of extensive
feasibility studies conducted by geologists and engineers based
on samples from the area in question. A mining company's reserves
are the lifeblood of its organization.
If a miner is pumping out 250
thousand ounces of gold per year but only has 1 million ounces
in reserve, investors are going to steer away from them. Unless
they acquire or discover new reserves, this miner would be out
of gold in three to four years. This shows the importance of
sustainability as analysts and investors consider two key pieces
of information when looking at a mining company. First is how
much does it cost to extract each ounce of gold from the ground?
And second, based on their reserves, is how long is their mining
life?
Reserves indeed indicate the
sustainability of a miner's business. One of the most important
business objectives of any mining and even energy
drilling company is reserve renewal. Investors need to have some
comfort outside of volatile commodities prices as to the life
expectancy and sustainability of the miner in which they are
going to invest.
Our first chart presents combined
mine production and reserves over the last five years for the
HUI components. As you can see both gold production and reserves
have been on the rise in unison with the gold bull market. HUI
components have amazingly increased their reserves by 46% since
2000. At the same time production has increased by 36%. These
are very sizeable and healthy increases which would seem indicative
to a bull market in their product.
A rule of thumb for healthy
gold producing companies is to maintain at least ten years of
reserves in the pipeline. As you can see above, HUI gold miners
have averaged and sustained about 15 years of reserves in the
last five years at their given production rates. Global sustainability
according to reserve and production data provided by the USGS
is projected at just about 17 years. So the HUI components appear
to be healthy compared to the global conglomerate.
With HUI production rising
each year and mine life maintaining and even increasing, it shows
successful reserve renewal. Now there are several different methods
for gold miners to renew their reserves. One common way is organically
through internally upgrading measured and indicated resources.
This happens on those projects the miner is already involved
in via reclassifying existing resources to an economically recoverable
status or discovering a new deposit on existing properties.
Rising gold prices play a large
factor in this organic renewal of reserves. As previously mentioned,
reserves only count as reserves if they are economically recoverable.
Three years ago it was not economical to recover gold if the
expenses were greater than about $350 per ounce. Therefore any
gold deposits that had estimated production costs in excess of
this amount were not deemed economically recoverable and hence
were not classified as reserves. Today gold that costs $400 or
even $450 an ounce to recover is now economically recoverable,
thus increasing reserves.
Another way for a company to
increase its reserves is through acquisitions. Just like in any
industry, gold companies have an affinity for M&As.
One thing that seems to set the gold industry apart from others
though is its perceived necessity for such. Investors that buy
gold stocks usually consider mining life. If a gold miner is
depleting its reserves faster than it is renewing them, it would
throw up a red flag and likely turn away investor interest.
If a miner cannot grow organically
and just does not have the physical land and resources to increase
its reserves, it feels pressure to either purchase someone else's
reserves or to acquire, merge or be acquired by someone else.
Many HUI components have taken these various routes in order
to stay attractive to investors and to sustain the longevity
of their businesses.
Reserves for HUI components
have been growing rapidly as they aggressively position themselves
in this gold bull market. Our next chart displays how global
reserves have fared in the last five years. As you can see, global
reserves have been on a noticeable downtrend over the years while
the HUI components have consistently taken on an increasing load.
According to the USGS there
were about 42,000 tons of gold reserves in the world at the end
of 2004, which equates to just over 1.3 billion ounces. Of those
reserves HUI components stake claim to over 26% of them. Because
of the aggressive reserve renewal practices of the gold miners
that comprise the HUI, they have increased their portion of global
reserves by 63% since the beginning of 2000.
Gold miners, especially those
of the publicly traded type, are no fools. There is no love lost
in the volatility of the commodities markets. When commodities
prices are down, specifically gold, miners are forced to cut
expenses, slash exploration budgets and cease production at non-profitable
mines. When the commodities markets are hot, it behooves them
to ramp up production and accumulate as many reserves and resources
as they can in order to take advantage of the bull. HUI miners
have certainly embraced this ideology.
Ramping up production and increasing
reserves is not that easy though. One reason why long-term
market cycles, especially commodity market cycles, tend to
flow and ebb in greater than ten-year increments is to allow
for the time it takes for economic imbalances to correct themselves.
It takes a great deal of time and money to construct a mine,
and when demand is rising without supply being able to keep up,
only rising prices through an extended period of time are going
to bring those forces together.
Even though gold demand has
sustained and should increase in the years to come, mined production
is having trouble keeping pace. In 2004 global gold production
was at its lowest level since 1997. And industry experts expect
gold production to drastically decrease in the next several years.
Mark Wellesley-Wood, the CEO of major gold miner DRDGOLD recently
wrote a commentary with several intriguing insights.
Mr. Wellesley-Wood said, "Despite
average annual increases in the price of gold gold production
is set to decline dramatically over the next four years, and
the effect could be irreversible. There are 29 new gold mines
in the pipeline right now and even if all these are developed,
it would require a further seven projects every year to make
up the deficit." Mr. Wellesley-Wood believes not all these
gold mines will come into fruition due to cost problems and his
concern is apparent when he exclaims, " where are the ounces
going to come from?"
Well as the chart below shows,
an increasing amount of these ounces are going to be coming from
the HUI component gold miners. In 2004 HUI components produced
26% of the global mined gold supply and they should continue
to lessen the spread as time goes on.
As Mr. Wellesley-Wood points
out, global gold production is indeed on the decline. In 2004
there was 5% less gold produced than in 2000. This shows that
gold production volume simply cannot increase with the flip of
a switch because prices are on the rise.
Many industry experts believe
production will fall due to the lack of exploration in the last
decade. Existing mines are running out of easy gold and watching
volumes decrease and expenses rise while new mines are absorbing
massive amounts of capital and time to get to production. Because
of the lack of exploration in the 1990s, new discoveries were
few and far between and now miners are scrambling to either make
these new discoveries or consolidate with those companies that
possess them.
This is just one of many fundamental
reasons why the price of gold should continue to rise in the
coming years. And with global gold production expected to continue
its decline, cascading further from its 5% decrease since 2000,
and with HUI production increasing by 36% in this same period
of time, its components represent an excellent start for stock
investors and speculators looking to take part in this gold bull
market. As the charts above have shown, the HUI is poised to
capture the interest and investment capital of an international
audience.
Gold is one cog in the wheel
of a massive commodities
bull market and should have many years left in its run. 2006
ought to be a great year for gold stock investing as the price
of gold continues to rise. The HUI indeed represents 15 of the
biggest and best gold miners, but there are hundreds of other
gold and precious-metals companies of all sizes that are jockeying
for investor funds.
At Zeal we have been recommending
gold stocks to our newsletter clients since gold was trading
under $300 and the HUI was below 50. Our research team monitors
hundreds of gold and precious-metals stocks of all sizes ranging
from junior
level explorers to major producers. We recently added over 20
of these stocks to our Watch List for subscribers and are monitoring
technical trends to help us determine optimal times to deploy
our capital.
Please subscribe
today and join us as we continue to provide cutting-edge analysis
and research on the commodities bull market. Our acclaimed monthly
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Intelligence and our active speculator service Zeal
Speculator provide our subscribers with an in-depth look
into today's and tomorrow's markets.
The bottom line is gold stocks
are poised for an excellent year in 2006 led by the venerable
HUI gold-stock index. Current market trends mixed with the long-term
economic imbalance in gold have provided miners and explorers
with the opportunity to shine as the market darlings of the years
to come.
Scott Wright
ZEAL
December 30, 2005
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