That’s Gold

At Edge7, we are taking a slightly different tack.  From time to time, we are going to write about a theme we have seen develop for positivity in the share market.

A wonderful set of circumstances
We have seen what we consider to be a wonderful set of circumstances emerge for investing in gold mining companies in recent months.  The factors that have contributed to these circumstances developing come from:

  • There has been pattern over recent years of higher gold prices in uncertain economic times.  Due to gold’s perception, as a safe haven, we believe this pattern looks set to continue.
  • The current global economic decline we are experiencing again will result in governments needing to act. With governments in Europe, USA, UK and Japan among other countries faced with two poor choices.  The choice being either deflationary policies such as austerity measures or inflationary policies such as quantitative easing, governments are more likely to choose the lesser of two evils which is inflationary monetary policy settings.  Inflationary policies we believe will be good for the gold price.
  •  Inflationary policies are more likely vote winners for those running advanced economies.  The alternative of imposing austerity measures on your people is not a popular move.  Backing the human interest of politicians around the world wanting to be re-elected by their populace at their next election, inflationary policies are a safer bet.
  •  The price of gold has fallen over the past number of months and may have reached a bottom for the time being.
  •  The $A falling about in line with the gold price in recent months has meant that Australian companies digging gold out of the ground and selling it have not lost any of their profit margins.
  •  With the gold price falling, we have seen the share price of some gold producing companies fall significantly more than the market.
  •  Some gold producing companies in Australia are forecasting to double and triple their production in the next year or two.

On the flip side
In contrast, a man whom I totally respect, Warren Buffett, has come out about a month ago talking about gold as an investment.  To paraphrase, Mr Buffett said that if we look over a long time frame such as the next 20, 50 or 100 years, buying physical gold will not be as profitable as buying into companies that produce goods or a farm that produces food each and every year.

And, I completely agree with him.  Gold bars sitting in a warehouse in the US Federal Reserve are not at all productive in the long run.   On a side note, it is my understanding that without Fiskalunion or a central bank, some of Europe’s gold reserves are kept in German Chancellor Angela Merkel’s garage, and I believe a few gold bars are now kicking around in the wine cellar at new French Prime Minister Francois Hollande’s home.

The pattern looks set to continue
In the short term, when looking over the remainder of this decade, the pattern of economic uncertainty appears set to continue as we lurch from one financial crisis to the next.  With this uncertainty will come a ‘flight to safety’ which at the current time includes a flight to physical gold.

With these set of factors emerging over recent months, we have developed the view that a few select Australian gold producing (not exploring) companies will do very well over the coming year or two.  We have made a two gold mining stock exemption to our no mining stocks rule.  And, we are not investing in the physical gold bar variety, but as Buffett says, companies that actually produce something which derives earnings.

We spend our days studying a large number of businesses listed on the Australian Stock Exchange.  At the current time, with the current economic uncertainty, we cannot find any other businesses listed on the ASX that have a confluence of all of these factors in place:

      1. Companies forecasted to double and triple current production and therefore, double and triple sales of their product in the next two years.
      2. The price of their product has the potential to rise materially in the near future.  (The gold price might go down materially, Caveat Emptor!!).
      3. Companies with no debt and actually plenty of net cash at hand.
      4. Companies with reliable and trustworthy management.
      5. Share prices of these companies have fallen significantly more than the share market in recent months.

 
Here is a chart of the (XGD) Gold mining sub-index on the ASX. It shows the collective decline in gold miner’s share prices over the past six months.

We have accumulated shares in two gold mining stocks listed on the ASX in recent weeks.  Last week, we wrote about one of these stocks for our subscribers and clients.  We will write about both stocks in our company report articles in the coming weeks.  We think the one we wrote about for our clients and subscribers is ever so slightly better than the other.

Caveat Emptor
In all of this, we reaffirm, buyer beware, we could be wrong!!!
The price of gold could retreat dramatically and the companies we have invested in could run into operational problems which reduce their productivity and hence, the volume of their product sold.

In summary,
We will be right if our hypothesis is correct, our facts are correct and our reasoning is correct.

That’s gold !!!

Postscript:  Since first drafting this article, we have made a third exemption to our no gold mining stock rule…oops!!.

This article is published by Dean Mico

The information provided in this article is intended for general use only.   The article is intended to provide educational information only.  Please be aware that investing involves the risk of capital loss.  The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person, nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.

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