As legendary commodity analyst Don Coxe observed, "The greatest investment opportunity comes from an asset class where those who know it best love it least."
This applies to gold stocks, which have been falling in the last 16 months for the following reasons:
- Perception of a housing-led US recovery
- Perception of crisis containment in Europe
- Perception of subdued or repressed inflation
- Poor management of gold mining companies
- Competition from U.S. equities
First, positive news on the housing front has led to strengthened belief in a U.S. economic recovery.
The problem is we are headed toward not just a housing recovery, but a new and dangerous housing bubble — engineered by the Fed and large private equity firms.
And once the market gets a whiff of the inflationary and disruptive implications of this bubble, perceptions toward gold which shift dramatically.
Second, the perception of crisis containment in Europe has been a major weight on gold and gold stocks.
In 2012, Mario Draghi unleashed a deluge of optimism by saying the ECB was ready to do "whatever it takes" to save the euro. This calmed markets with the illusion of stability.
But events in Italy and Cyprus will shatter that illusion. The turmoil of Italian elections and the horrible mismanagement of the Cyprus bailout are both major foreshadowing events for what awaits the euro zone.
Third, it is widely believed that inflation has been tamed — naturally bearish for gold and gold stocks.
The main official measure the Fed watches, CPI-U, has not been registering increasing inflation pressure. But this will remain the case only as long as monetary velocity — which measures how fast money moves through the system — and bank lending remain subdued.
And that is not likely to remain the case. Because either perception of U.S. economic recovery will persist and cause a pickup in spending and bank lending (and, therefore, inflation). Or fear of the Fed overshooting on its policy near-zero interest rates and debt monetization will ignite a 1970s mentality of "spend it now" ahead of big price rises.
Fourth, gold stock valuations have been greatly compressed by gross misuse of cash flow.
Gold mining companies have long been known for their terrible management — everything from badly judged acquisitions of new mines, to botched hedging strategies that wipe out positive exposure to the gold price, to paying nosebleed prices for takeovers of competitors.
But even the hardheaded management teams can learn. And pessimism has driven valuations to rock-bottom levels, even as managements have promised to go to the equivalent of Alcoholics Anonymous — call it "Acquirers Anonymous" — to stop throwing money away on bad projects.
Fifth, gold stocks have suffered on a relative basis as institutional capital piled into more conventional areas of the U.S. equity market. Health care, retail and housing-related stocks have done exceptionally well in the past months — again, based on perceptions of U.S. recovery.
But now those areas of the market are overbought and overvalued, as gold stocks scream value and bargain-basement prices.
It is rare to see so many macro factors converge like this in favor of one area of the market. I recommend you "back up the truck" now ahead of gold miners' big move higher.
You can add exposure to gold miners through the Market Vectors Gold Miners ETF (GDX).
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