Markets

This Simple Chart Says Gold Stocks Could Soar

Opportunities like this are rare. They only present themselves when investors are scared, and right now they seem terrified.

Let me explain...

The recent market turmoil has investors ducking for cover -- even seasoned pros have been a bit stunned by the violent pullback. Of course, you can't blame anyone for being a little jumpy these days, given the tumultuous debt-ceiling debate and subsequent Standard & Poor's U.S. credit ratingdowngrade ; not to mention the ongoing financial troubles in Europe.

For the first time ever, the Dow Jones whipsawed to wild 400-point swings in four consecutive trading sessions. And thebenchmark S&P 500 slid as much as 17% in just two weeks.

As you might expect, gold has been the single-biggest beneficiary of the panic. With prices racing to $1,800 an ounce, the metal has lived up to its reputation as a reliable hedge in turbulent times -- delivering an average year's worth of gains in less than 30 days.

Normally, this wouldmean good news for the companies that actually dig the stuff out of the ground. As the prices of precious metals rise, the stock prices of the companies that mine those metals often go with it.

But gold stocks haven't been as fortunate. Most gold-mining stocks have been sucked into the same black hole that has ensnared other equities.

After marching together for most of the past year, notice the divergence that has opened up between gold stocks and gold bullion:

This chart shows the return of gold versus the Market Vectors Gold Miners ETF (NYSE: GDX ) , a proxy for gold mining stocks. If you look back over a five-year period, the difference is even more striking.

In my mind, gold stocks were already a betteroption to begin with. For one thing, many miners pay regular dividends -- whereas, to paraphrase Warren Buffett, gold bars just sit there and look at you.

But here's the best news. We've seen the prices of gold bullion and gold equities get completely out of whack several times in recent years. And when the market regains confidence, the divergence tends to correct itself.

This situation looks remarkably similar to November 2008. Much like today, stocks of all shapes and sizes were plummeting amid the financial crisis, with mining stocks suffering an overdone 60% selloff. But gold stood its ground.

However, these imbalances usually don't last long. As you can see from the chart below, once the crisis abated, gold-mining stocks came racing back:

-- Nathan Slaughter

Fortunately, I recommended that readers of my Market Advisor newsletter start accumulating shares of GDX in November 2008, when most other investors were still running for the exits. The shares bottomed shortly thereafter and doubled in price in the following seven months. I collected my profits in June 2009, once the gap narrowed.

Now, I'm not necessarily saying we'll see a repeat of that performance; the disconnect was more pronounced back then. But for those of you looking for some exposure to gold, then mining stocks may be your best bet.

But which one? Keep in mind, all miners are NOT created equal.

Action to Take --> When picking favorites in this sector, I pay close attention to five main factors: extraction costs (the lower the better), production rates (preferably rising), reserve base (ditto), geographic location (be cautious of geopolitical trouble spots), and hedging (ideally none in a buoyant market).

There are other considerations, of course, such as valuation. But this is a good start. And by this checklist, Goldcorp (NYSE: GG ) has been my top pick for the past two years.

With more than a dozen high-grade mines throughout North America, Goldcorp is the lowest-cost producer in the business. After byproducts such as copper and zinc are sold, the company can get an ounce of gold to market for just $185 per ounce -- even before this run-up, Goldcorp got an average price of $1,516 per ounce for gold in the second quarter of the year.

And if history is any indicator, then gold stocks are ready for a rebound, making right now a potential buying opportunity for Goldcorp and other mining companies.

P.S. -- The disconnect in gold isn't the only one I'm finding. In fact, the natural resources sector is full of them. There's simply so much demand coupled with real scarcity. You can get more details by watching this free webcast I recently put together.

Disclosure: Neither Nathan Slaughter nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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