Jeff Mishlove: All That Glitters is NOT Gold

Wednesday, 4 Apr 2007 | 10:58 AM ET

Guest blogger Jeff Mishlove is back with a post. He's called it "All That Glitters Is Not Gold." Let's get right to it: Recently, I saw a cartoon where a man and woman had discovered a big, black pot at the end of a rainbow. But, when they looked inside for the gold, instead they discovered that it was full of baked beans. I suspect that many speculators, seeking to cash in on gold’s bull market, have sometimes felt much the same. Yet, I believe that gold, currently priced at about $665/oz., is about to move up to test last year’s high of about $730/oz., and perhaps move even higher.

Gold serves as a hedge against inflation and a refuge in times of crisis; it is also a very good alternative to the use of fiat currencies for storing wealth. Given the tense global situation today, it is very likely, in my view, that there will be opportunities for Portfolio Challenge contestants to take advantage of an upward price movement in gold. Of course, the contest does not allow trading in gold futures, nor even in the gold ETF . This is not really a problem, however, because one of the best ways to invest in gold is by buying stock in gold mining companies. Naturally, there are many complexities in the mining business. But, in this guest blog, I will offer a simple and straightforward perspective.

My colleague, Jim Driscoll, has identified six different tiers of gold mining companies. His analysis is very helpful in determining which companies are poised for a dramatic price increase.

The first tier companies are large and well established gold producers. They range in size from Goldcorp , with a $16b market cap, to Newmont with a market cap of about $25b. This tier also includes some larger companies like Anglo American that engages in a wider variety of mining and resource exploration. Because of their size and dominant position, these companies afford less opportunity for speculators than those in the lower tiers.

In the late 1970s, during the last major bull market in gold, it was the lower tier companies that showed the greatest stock price appreciation.

The second tier companies are smaller producers of gold. They range in size from Meridian Gold , with a $2.6b market cap to Agnico-Eagle , with a market cap of $4b, to Kinross Gold with a market cap of about $8b. Two years ago Goldcorp was in a position similar to Kinross’s which today has the potential for becoming a first tier company thru acquisitions.

One of the ironies in the mining business is that established companies, whose costs of production are relatively low, gain less value from a price increase in the underlying commodity than a company with higher production costs. This is because the percentage of increase in the profit margin is generally greater, as the price rises, when the production costs are higher.

Third tier companies often have greater profit potential than their larger brethren. These are the ones that have only recently begun actual mining and gold production operations – and they are still ramping up. They range in size from Aurizon , with a market cap of $570m, to Gammon Lake Resources , with a market cap of $1.8b, to Yamana Gold , with a market cap of about $4b.

Companies in the fourth tier are about to start producing gold from significant proven reserves to which they have acquired rights. They range in size from Minefinders (MFN), with a market cap of $571b, to Novagold with a market cap of $1.6b.

In the fifth tier are companies that own gold reserves, but are farther from actual mining operations than those in tier four. A classic example here is VistaGold , with a market cap of $240m. Companies in the fifth and sixth tiers are too small to be considered for the Portfolio Challenge. Sixth tier companies are small explorers without working mines, whose reserves are not fully documented.

In my view, the model company for investment purposes is Yamana Gold which recently made the transition from the fourth to the third tier. Its price rose about seven-fold, as can be seen in the following, five-year chart.

Note that during the last two year period, Yamana far out-performed gold itself.

So, the obvious question is what company currently in the fourth tier is about to move up into the third tier in a manner as dramatic as AUY? And, the answer is that there is such a company and, in fact, it is one of the companies eligible for the Portfolio Challenge. That company is Minefinders , whose three-month chart is shown below:

There is good reason to think that Minefinders today is positioned about where Yamana Gold was approximately two years ago. MFN has substantial reserves of both gold and silver, especially in relationship to its stock value. In fact, just last Friday, the stock experienced a dramatic price jump. They are expected to begin producing gold in the autumn of 2007. As they gear up to produce, more price jumps can be anticipated.

If you pay close attention to these mining companies, you’ll see that the businesses can glitter more than gold itself. And, you’ll end up with more than baked beans for your efforts.

Jeffrey Mishlove is creator of www.forecastingsystems.com. He is a registered commodity trading advisor; and is also a licensed psychologist. He serves as president of the nonprofit Intuition Network.

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