WHEN GOLD'S DAY COMES
By Dr. Steve Sjuggerud
Somehow, the U.S. has ended up with two major gold-stock
indices. But unlike the Dow Jones Industrial Average and
the S&P 500 Index, which have shown similar returns on the
overall stock market for nearly 80 years, the gold indices
just can't seem to agree...
One is up about 100% since the beginning of 2002, while the
other is up only 20%. What's going on? Why should we even
care?
The explanation of the strange behavior of the two gold-
stock indices is your introduction to the market for gold
stocks, where you can make a bundle or lose it all,
depending on whether you make the right moves.
We should care about gold because there are few industries
out there as hated as gold mining right now...and this
means that when the turn in gold-mining stocks finally does
come, the rewards could be truly extraordinary.
Now is not the time to buy gold-mining stocks, but the time
is getting close. Once we see the "important" gold-mining
index start an undeniable uptrend, it will be time to
buy...
But which gold index is the "important" one? The two major
U.S. indices are the "XAU" Index and the "Gold BUGS Index."
Each is distinguished by the stocks that make up the
respective indices.
The XAU is actually the Philadelphia Stock Exchange Gold
and Silver Stock Index. It's a way to take the pulse of
generic mining stocks. It has been around since 1983, and
it's the industry standard.
The Gold BUGS index is not an index of generic mining
stocks. It is specifically a gold index, and will
specifically contain only "non-hedged" gold mining
companies - those that are fully exposed to the price of
gold, for better or worse.
This is where the important difference between the two
indices lies. The largest two stocks in the XAU Index are
Barrick Gold and AngloGold. Yes, these are two of the
world's largest gold-mining companies. But they also
significantly "hedge" their bets - putting themselves in a
position where a significant increase in the price of gold
above a certain price may not necessarily benefit their
business.
Barrick has hedged about $6 billion of future gold
production at $341 an ounce. AngloGold has 9 million ounces
hedged - closer to $3 billion.
Hedging may be a prudent business decision. It's helped
smooth out the losses for Barrick in a down gold market.
Barrick states, "Between 1991 and 2002, Barrick's forward
sales program [its hedging] allowed the company to secure
an average premium of $67 per ounce on the 32.6 million
ounces of gold we sold, generating additional revenue of
$2.2 billion. Barrick's forward-sales program eliminates
one of the biggest risk factors facing our business [the
price of gold]. By managing this risk, Barrick can expand
its asset base, increase its mineral reserves and
production, and, most importantly, generate predictable
returns for our gold sales."
Unfortunately, when the market is roaring higher, a hedging
program will also smooth the profits out in an up market -
meaning the gold companies that have hedged their bets will
not make nearly as much money as those that aren't hedged.
As an investor looking to get the most bang for your buck
out of gold, hedged gold stocks like Barrick and Anglogold
are not your best choices. Yet these two stocks make up
about 45% of the XAU Index - the inferior index. I consider
the Amex Gold BUGS index (symbol ^HUI) a much better index
to track...
The Amex Gold BUGS Index (the "BUGS" part actually is an
acronym for Basket of Unhedged Gold Stocks) is much younger
than the XAU Index, having started in 1996. It is a better
gauge for how gold shares are acting in relation to the
price of gold. The two major stocks in this index are
Newmont Mining (NEM) and Goldcorp (GG).
When you consider the fact that Newmont, the world's #1
gold miner, only has a market value of $1.3 billion, you
can see that the world of gold-mining is incredibly tiny.
If you added up the value of every gold mining stock on the
planet (roughly 2,000 companies), it would only come up to
about half of what the tech stock Cisco trades for...
When gold's day comes, an unhedged gold stock like Newmont
could do extraordinarily well. Remember, the company is
only valued at $1.3 billion. But get this: It has $419
million in cash! So the value of "the business" is closer
to a tiny $880 million. This is a company with gold
reserves of 87 million ounces - with a current value of
nearly $30 billion dollars! Using Newmont as an example,
the downside should be limited, due to its gold hoard in
the ground. Yet the upside potential could be huge.
You can use the standard analysis tools to analyze gold
companies, as long as you compliment your analysis with
some scrutiny of their gold. With gold companies, you must
also consider the cost per ounce of production and the
state of gold reserves themselves. Cash costs of production
at Newmont, for example, are expected to be around $200 an
ounce in 2003. So gold, at $335, is nicely profitable.
Reserves, again, are 87 million ounces.
The websites of Newmont, Barrick and AngloGold spell out
all the details in their "analyst" and "investor relations"
sections, including their hedging activity, their reserves,
their costs per ounce, and more. Online, go to
www.newmont.com, www.barrick.com, and www.anglogold.com,
respectively.
Before investing in gold shares, start with these three
websites to get your feet wet and gain an understanding of
their businesses.
Then, when the time is right - when we see a clear uptrend
in the Amex Gold BUGS Index - you may want to consider
investing in an unhedged gold producer, like Newmont,
Goldcorp, Kinross or another member of the Gold BUGS index.
Sincerely,
Steve Sjuggerud, PhD.
for The Daily Reckoning |
