Gold Stocks in a Rising Gold Market

While there are a number of ways to play rising gold prices, my personal favorite is the higher-quality junior precious metals exploration companies. Those are companies with a high-risk profile (few will ever actually make an economic discovery), but you can apply analytical screens to them that greatly lower that risk…leaving some truly extraordinary upside.

How extraordinary? While an extreme example, on the back of the Eskay Creek discovery Consolidated Stikine Resources went from 10 cents per share in 1988 up to a high of $73 in 1990, a stunning 70,000% gain!

These stocks do well during periods of crisis for several reasons, but mainly because they are such a small sub-set of the financial landscape that even a fractional increase in interest sends them soaring. And this time around, I think we are going to see the high end of the range that these stocks are capable of, for the following reasons:

Increase in Equity Accounts
Thanks in no small part to the dot-com boom, never before have more North American households been involved in equity markets.

As the gold stock story filters through to them, they’ll find it highly appealing and he’ll have the ability to act immediately. Furthermore, such people are trend followers; they know nothing except to buy stocks that have a positive chart. For the first time since the Internet bubble burst, they’re going to have a real tiger by the tail. In other words, for the very first time in their history, gold stocks are going to have not only the cognoscenti but the unwashed masses piling in. The bull market will be breathtaking when this gets underway.

Meteoric Rise in Hedge Funds
In a similar vein, we now have the whole new phenomenon of hedge funds, which have grown like kudzu all over the financial tree. They were a non-factor in earlier bull markets, but now number over 12,000 and manage on the order of $1 trillion. Moreover, the majority of these funds are run by twenty- and thirty-somethings with little experience in a real bear market and are herd-like and aggressive to boot. Gold is increasingly finding favor as an asset class with the hedgers.

The Rise of the AIM
Thanks in no small part to the incessant meddling by U.S. regulators, London’s AIM is increasingly becoming the “go to” market for resource companies, offering these companies exposure to a wider audience than the less trafficked Canadian markets which have traditionally been home to the junior exploration companies.

Convergence of Higher Gold Prices and Discoveries
Perhaps most important is that, for the first time ever, we should witness a round of economic mineral discoveries against the backdrop of a major bull market in gold (and silver) prices.

The trickle of financings for precious metals exploration that began soon after gold’s 20-year bear market came to an end in April of 2001 has turned into a small flood. In fact, according to the Metals Economic Group, in 2006 the amount of money raised for exploration topped $7.6 billion, the fourth year in a row that there has been an increase, and the highest total since they began tracking the numbers in 1989.

All that money, much of it in the hands of teams headed by experienced pros let go by the large gold companies during the long bear market, has set off a massive number of new and fast-moving exploration initiatives, using the latest technology and squarely focused on the world’s most prospective geological addresses. It is not a matter of “if” there will be significant discoveries, but “when.”

If all unfolds as it can, and likely will, for the first time ever, we’ll benefit from a concurrence of a discovery market with much higher precious metals prices. Toss in a lot of investors with a lot of cash, nervous about the outlook for global financial markets and looking for a trend to fall in love with, and you have all the elements necessary for you and me as early investors in the resource sector to pull down truly extraordinary gains.

Don’t get overly greedy, and don’t mortgage the house to buy gold stocks. But do make sure that you move toward being fully invested… which, depending on your willingness and ability and level of risk tolerance, might take you up to 20% – 25% of your portfolio.

You’re going to find good reason to love gold stocks. But I hope you won’t fall in love with them. Although I’m a philosophical gold bug, I’m not always a gold bull. I always keep in the back of my mind that gold shares aren’t heirlooms, they’re burning matches. And while I still think this market will see gold’s biggest run in history, when it’s over these stocks will lose 90% of their value… as does any class of stocks when a mania ends. But the good news is that the mania hasn’t even begun.

Editor’s Note: Doug Casey is the author of Crisis Investing, one of the few financial books that made it on the New York Times Best-Seller list…and spent 26 weeks there, ranking number one. Due to his contrarian views, Doug is a well-known and popular speaker at investment conferences. He is also the editor and publisher of the Casey Energy Speculator, a publication dedicated to junior exploration stocks in the energy sector – stocks with the very real potential to deliver gains of 100% or more within 12 to 24 months.