Steven Kaplan:
SUMMARY: My current outlook for gold and gold mining shares has deteriorated sharply to SIGNIFICANTLY BEARISH. The XAU and HUI are not nearly as overvalued as they were in the late spring and early summer, which is the only reason I am not strongly bearish. However, commercials are net short more than 90 thousand contracts of COMEX gold futures, which is a typical warning of an overbought market. Media coverage toward gold has been almost universally positive in recent days, and there has been sparse put buying in gold mining shares, while call buying has returned to its late spring euphoric levels. Also, senior gold mining shares have been far underperforming junior producers. Barrick and Placer Dome are barely trading above their lows of the past several years, even with the gold price itself much higher, whereas smaller companies such as Glamis and Hecla have been soaring; in the case of Glamis and several others, the share prices are back to the levels of the mid-1990s when gold was $80 per ounce higher than it is today. Insider selling by top management has repeatedly emerged in these juniors even at prices below current levels, proving that those who know most about these companies are quite skeptical of the public embracing their shares at these inflated valuations. In the overall stock market, when companies such as Lucent and Nortel are finally joining the party, you know the overall technology rally is almost done; similarly, when the juniors are far outpacing the seniors, the party is about to end. It should be emphasized that almost the entire improvement in the price performance of junior gold producers is a result of their P/E ratios expanding from an average of 13 two years ago to an average of 55 today, rather than to improved earnings. That doesn’t make their rally any less “real”, but it should serve as a warning to investors in these companies, since such P/E expansion cannot continue indefinitely. After selling at a discount of as much as 23% to net asset value in October 2000, and averaging around a 13% discount over the past several years, the closed-end fund ASA is selling at a premium of 2.2% to net asset value, according to the most recent edition of Barron’s. The closed-end fund CEF, which is nothing more than gold and silver bullion stored in a vault, is selling at a premium of 16.5% to net asset value! This demonstrates a public overeagerness for gold and its shares. From a seasonality viewpoint, gold has lately been peaking in the last month of each quarter (June, September, December) and then bottoming several weeks thereafter. Commitments for most currencies show that insiders are expecting a U.S. dollar rally. There has been so much anticipation that the new Bush appointees are about to declare their support for a weaker American currency that even a lukewarm comment such as “we intend to maintain the current administration position toward the greenback” would likely be enough to send the U.S. dollar sharply higher, which would be correspondingly negative for gold. When purchasing any securities, gold mining or otherwise, avoid buying on margin and never purchase call options, so that the magnitude of the eventual gain is the only important issue, rather than the vagaries of precise timing or interim volatility. Always stick with companies that have strong, growing earnings; avoid companies with losses. Occasionally a money-losing company will suddenly turn around and become profitable, but that is the rare exception.
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