Gold bugs had a great 2007 with the yellow metal gaining more than 25 per cent in value. But it was not such a good year for holders of shares in major gold producers whose performance was lacklustre and worse still for investors in gold juniors. This is strange as gold companies should lever upwards against the gold price. Will it continue in 2008?
The short answer is probably not, and that could well make gold shares one of the best investments for 2008, which may prove to be a very poor year for many traditional investment classes, and almost certainly a very volatile 12 months.
Big gold mining companies like Newmont, Gold Fields and Barrick Gold all suffered from higher energy and production costs that hit profit margins in 2007. Yet the price of gold is up from $650 to $824 an ounce since the start of the year, and so revenues at the major producers are set for a hike too.
If the gold price continues to gain in 2008 then the current lag in the valuation of gold companies is a serious buying opportunity. Of course, it could be that a Wall Street correction or crash will drive gold equity prices even lower in 2008, but that would surely signal an even better buying opportunity.
There is another way to read the current weakness of gold shares: the share price could be predicting a fall in the gold price from current levels. This is not as far fetched as it might sound. For in recent corrections on Wall Street there has always been a parallel sell off in commodities like oil and precious metals. Therefore, goes the logic, in a bigger Wall Street correction the gold price would tumble.
Could you not then argue that buying gold shares in a major Wall Street dip would likely prove an excellent buy as the gold price would likely recover relatively quickly in such an environment?
Certainly one reason to expect the gold price to tumble with Wall Street is the inverse relationship between gold and the US dollar: so as Wall Street sold off and investors moved into cash, gold would fall in value.
But then again if this sudden US dollar rally gave way to a further loss of confidence in the greenback, gold would be the place to be invested. The difficult part for investors today is to decide whether gold shares are due for another down period before they move up, or whether the pessimism of 2007 for gold shares has been overdone given the recent strong gains in the value of physical gold?
It is not an easy call to make. But should shares in Dubai-listed Gold Fields, for example, be ending 2007 around $14.50 when they started the year at $18.50, while spot gold is up 27 per cent?
And if this is a bargain, then the junior gold companies and gold explorers are an absolute snip. Many of these companies are trading on share prices not seen since gold was $500 an ounce, and yet in the past, during gold bull markets, these shares have delivered by far the best returns.
There is a good argument for buying these shares now, literally while stocks last, as the problem in a bull market is that you cannot obtain these shares in sufficient volume to make a large investment. And buying shares that have an excellent outlook while prices are cheap remains the way to maximise returns, and patience is just a part of this game.
Veteran US gold analyst Joe Granville tips the tiny Linux Gold
as his pick for maximum capital gain for this reason. But choosing junior gold stocks is a tough call even for the professionals. And the tightly gold price-leveraged Seabridge Gold, for instance, has tripled in value in 2007 while Linux Gold has gone nowhere despite acquiring a new gold discovery.
The gold market is also concerned about a repeat of the 1975-1976 halving of the gold price that followed the 1974 Wall Street crash. If Wall Street crashes next year will the same thing happen again? It might but then the eight-fold bounce in the gold price by 1980 should not be forgotten either.
Or go back to the 1929 Wall Street crash, and look at the continuous rise in the share price of Homestake Mining from $80 in October that fateful year to $500 in 1935, a compound annual return of 35 per cent during one of the worst ever recorded periods for investors.
The conclusion would surely be that the smart investor in 2008 will put some money into gold shares as a safe long-term hedge against a very uncertain investment outlook.
If you do get a nice short term return as well then fine, but think longer term for maximum returns on gold stocks.
The question is whether gold stocks will continue to outshine gold in 2008?