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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Gold $400 and The Relationship Between the Gold Price and Gold Mining Stocks

Commodities / Gold & Silver Stocks Jul 16, 2007 - 09:38 AM GMT

By: David_Vaughn

Commodities

GoldThe US dollar continues to see saw back and forth. And as the dollar continues to demonstrate its weakness gold will continue to dig deeper into its present 600 per ounce foundation.

Here is an interesting thought. How will gold do when it hits 400 an ounce? You say wait a minute, Dave, its already passed 400 an ounce. So what is my point? My point is to illustrate the significance of the gold price. Whether it's 300 an ounce or 500 an ounce or even 400 an ounce.


“The good news is that the strong gold price increase of more than 50% from $ 400 to above $ 600 has a positive impact on the valuation of gold reserves, as gold majors have valued their reserves at an average of $ 400.” Click

I remember well those days not too long ago when gold was struggling to come out of a 20 year bear market. And make no mistake that gold has exited that bear market. But where is gold now? Is gold in a bull market? Is gold heading back to a long term bear market? Or is gold destined to swing and fluctuate back and forth forever in a 10 or 15% range?

And maybe the question to ask is what does it even mean when gold goes up or down? What really is on the line here? When gold was around 260 an ounce a 400 dollar gold price was beyond imagination and only a dream. I really wonder how few there are in today's market that can even remember when gold first ascended the 500 dollar mark in the fall of 2005? I don't think many. Where are we in this gold market presently? Consider the article below that came out right as gold ascended the 500 dollar barrier.

“Markets love round figures and yesterday $500 was broken for the first time in about 20 years.”“$500 in our view is just a staging post with the next move going to $519-$530.” Click

Did you catch the above older article? Gold is headed to the unheard level of potentially 530 dollars per ounce! And you are now concerned because gold occasionally fluctuates to 630 an ounce? Give me a break. Why do we get excited when we see gold climbing north of 650 an ounce? Why do we become frightened and despondent when we see gold below 630 an ounce? So really to whom is the price of gold really important to? Well, we have this vague notion that as gold climbs the price of gold shares rise correspondingly. So unless gold is rising our gold shares are worthless and dormant? What is the truth folks? What price does gold have to sit at for us to make money?

Dan diBartolomeo – “While the gold price is the single most influential force in determining the behavior of gold mining shares, gold stocks are not nearly as sensitive to gold prices as current financial models suggest they should be.” “Putting realistic numbers into the formula, the remarkable aspect begins to take shape. Assuming that the price of gold is $400 per ounce and direct mining costs are $300 per ounce. The gross profit is $100 per ounce. Note that the value is linearly related to this gross profit. If the price of gold changed to $500 per ounce (a 25% increase), the gross profit would be $200 per ounce, and the forecast price of the stock would rise 100%. The percentage change in valuation of the equity position is four times as great as the percentage change in value in the commodity asset.”

What do we want? What is our objective? Well, we like gold stocks because they are strongly leveraged to the gold price and as gold goes up our shares go up. Well, there is much, much more to this equation. Forget momentarily about the price of gold climbing. What is really pertinent to whether our gold shares do well is that the individual mining company we bought into is making money.

And common sense will tell you that there are many more factors attributing to a company's profitability than solely the price of gold. I am not discounting the importance of the price of gold, but you don't just buy arbitrarily any gold company stock just because gold appears to be on a tear. As I have said over and over and over again your objective is to make money and that is where the value of high quality mining companies can really prove their worth.

“…the race is on amongst the biggest gold-mining firms to re-stock their depleted reserves. Three of the larger gold mining companies have just said they're going to spend record sums trying to find new gold-in-the-ground. Picking the winning stocks – and selecting the junior miners about to receive fresh takeover bids – could pay handsomely.” “…merger & acquisition spending in the gold sector alone was nearly three times as much according to analysis by Merrill Lynch.” “If you're looking for the bull market in gold to run beyond the end of 2007 – and Blackstone Merrill Lynch this week forecast that we're only mid-way through a rising commodities market seen once every 50 years…” Click

A higher quality gold mining company might just find its shares climbing as the price of gold is dropping. So the real point in our understanding should be what really determines if a share is under valued and will contribute to its climbing higher. And yes, other factors are often more important than the price of gold itself. Which stocks are making money and which do you buy? Read the text below and absorb its powerful message.

Scott Wright “When investors do their homework and perform their due diligence in choosing companies in which to invest, they will find one miner can be vastly different from another. Some companies are able to produce an ounce of gold for cash costs of under $100 an ounce, and some are spending an average of over $400 an ounce to produce an ounce of gold.” “…due to the outstanding leverage these miners have, you can't tell me gold-mining stocks have lost the air in their sails.” “Gold miners' profits appear to be healthy, do not be swayed to believe otherwise.” “In picking individual stocks in which to invest, it is important to identify those that are well positioned to leverage outstanding profits in today's and tomorrow's markets and those that prudently manage their expenses.” “The bottom line is even with rising costs in gold production, gold-mining profits are still healthy.” “Investors that are positioned in the stocks of those gold producers best leveraged to their underlying metal and able to efficiently manage their expenses should reap legendary rewards.” Click

Did you read well the article above? A simple, but very essential and important message. Buy quality mining shares. When gold was 300 an ounce we prayed for 350 an ounce because we knew there were companies that could make substantial profits at 350 an ounce. And what about 400 an ounce? Generally, 400 an ounce is considered a good number because even more companies can economically make money developing a project. So if this is true then there is even more money to be made at 500 an ounce, right? And at 600 an ounce profits only further increase. Right?

“…if you own a share in a gold mine where the costs of production are $300 per ounce and the price of gold is $600, the mine's profit margin will be $300. A 10% increase in the gold price to $660 per ounce will push that margin up to $360, which actually represents a 20% increase in the mine's profitability, and potentially a 20% increase in the share price.”Click

But let's get back to that 400 dollar an ounce valuation. 400 is an important number just because so many companies can operate profitably at 400 an ounce and develop economically their deposit. So the question we ask ourselves then is why do we get so stressed out when gold climbs over 400 an ounce and on to 600 but yet oscillates between 6% and 7%?

“In mining, many projects which were not economically viable at gold prices below $ 400 are now being reactivated and will have a positive impact on gold production in the next few years, enhanced by a growing number of mid-tier producers. Within this scenario it is intriguing to watch that the overall price performance of gold shares has stayed well behind the boom in the bullion price, thereby offering many attractive investment opportunities.” Click

The point that I am driving home here is that the gold mining company that finds itself profitable at 400 an ounce then climbs to 600 per this same company will still be profitable if gold heads back to 400 an ounce. So again what is my point I am attempting to drive home here? Please read the following older news text below.

“Gold's recent performance has been very, very satisfactory. It is currently consolidating above $550oz…” 1-31-2006 Click

Now let me ask a question here. If gold a mere year and a half ago was at 550 per ounce and considered then to be “…very, very satisfactory.” Does gold now cease being very, very satisfactory at 650 per ounce? Give me a break. Folks, the gold mining industry is not going to collapse if gold heads back to 500 an ounce or lower. And personally I do not even see it descending below 600 an ounce anytime soon. And if I am not worried about a 500 dollar an ounce price I sure as heck am not going to lose sleep if gold drops to around 600 an ounce. Folks, there are still profits being made and most of our quality mining shares are going to continue to do well and to climb higher.

Why is it so important to go over these numbers time and again? Well, if these principals are not understood you will not make any money whether gold is 500 or 600 an ounce. This game is all about the pursuit of companies worth pursuing. And when we ask ourselves which company is the better speculation we are then asking the right question.

“While it took the gold price two years to increase from $ 400 (December 1, 2003) to $ 500 per ounce (December 2, 2005, it took just four months and one month to pass the $ 600 and $ 700 barrier respectively, recording a new high of $ 725.75 at May 12.” Click

All these mining shares are speculations but which remain the better speculations? And if you can succeed in picking on average the better speculations you are going to make money – period. This game is all about averaging. And when your batting score is on the up and up it is only inevitable that the homeruns will start occurring. And as any baseball player understands it is the welcomed home runs that win the game.

Mining is a continuous ongoing business. There are always new deposits being discovered. There are always established deposits that soon will be in a production mode. Quite frankly it is safe to say that there are always shares that will climb high making their shareholders rich. But you have to be in the game to play. And most importantly you must understand this game and process.

The truth is there is money to be made in gold mining shares. How much money? That depends on your ability to self educate. Also, your ability to make money will ultimately depend on your success in learning who to listen to. And I really do say that last comment is the most important. This sector is literally loaded with excellent analysts whose work appears in prestigious financial publications. I just have no pity for anyone who wants to make money on the cheap. Success always comes at a great deal of cost. You want something free? Go to your local soup kitchen. But even in a soup kitchen someone still pays with their time and donations for that “free” meal.

We are in a new last day's investment era. Natural resources, such as gold and uranium, will only escalate in value as the world continues to experience unprecedented growth. Gold Letter's 10 best performing stocks are up over 2,000% and GL's top 55 performing stocks are up over 500%. Close to 90% of all Gold Letter's recommendations since inception in January, 2003 are up over 250%. GL charts are computer generated and updated every hour while markets are open.

Click here to order Gold Letter

“…there is a convergence of global events that will have profound implications for our world. The effects of the convergence are just now beginning to manifest themselves in our country.” Doug Tjaden, Traditions of Men

By David Vaughn
Gold Letter, Inc.
David4054@charter.net

The publisher and its affiliates, officers, directors and owner may actively trade in investments discussed in this newsletter. They may have positions in the securities recommended and may increase or decrease such positions without notice. The publisher is not a registered investment advisor. Subscribers should not view this publication as offering personalized legal, tax, accounting or investment-related advice. The news and editorial viewpoints, and other information on the investments discussed herein are obtained from sources deemed reliable, but their accuracy is not guaranteed. © Copyright 2007, Gold Letter Inc.

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