When Gold's Day Comes

Somehow, the U.S. has ended up with two major gold-stock indices. But unlike the Dow Jones Industrial Average and the S&P 500 Index, which have shown similar returns on the overall stock market for nearly 80 years, the gold indices just can’t seem to agree…

One is up about 100% since the beginning of 2002, while the other is up only 20%. What’s going on? Why should we even care?

The explanation of the strange behavior of the two gold- stock indices is your introduction to the market for gold stocks, where you can make a bundle or lose it all, depending on whether you make the right moves.

We should care about gold because there are few industries out there as hated as gold mining right now…and this means that when the turn in gold-mining stocks finally does come, the rewards could be truly extraordinary.

Gold Indices: Gold Mining Stocks

Now is not the time to buy gold-mining stocks, but the time is getting close. Once we see the “important” gold-mining index start an undeniable uptrend, it will be time to buy…

But which gold index is the “important” one? The two major U.S. indices are the “XAU” Index and the “Gold BUGS Index.” Each is distinguished by the stocks that make up the respective indices.

The XAU is actually the Philadelphia Stock Exchange Gold and Silver Stock Index. It’s a way to take the pulse of generic mining stocks. It has been around since 1983, and it’s the industry standard.

The Gold BUGS index is not an index of generic mining stocks. It is specifically a gold index, and will specifically contain only “non-hedged” gold mining companies – those that are fully exposed to the price of gold, for better or worse.

This is where the important difference between the two indices lies. The largest two stocks in the XAU Index are Barrick Gold and AngloGold. Yes, these are two of the world’s largest gold-mining companies. But they also significantly “hedge” their bets – putting themselves in a position where a significant increase in the price of gold above a certain price may not necessarily benefit their business.

Barrick has hedged about $6 billion of future gold production at $341 an ounce. AngloGold has 9 million ounces hedged – closer to $3 billion.

Gold Indices: A Prudent Business Decision

Hedging may be a prudent business decision. It’s helped smooth out the losses for Barrick in a down gold market. Barrick states, “Between 1991 and 2002, Barrick’s forward sales program [its hedging] allowed the company to secure an average premium of $67 per ounce on the 32.6 million ounces of gold we sold, generating additional revenue of $2.2 billion. Barrick’s forward-sales program eliminates one of the biggest risk factors facing our business [the price of gold]. By managing this risk, Barrick can expand its asset base, increase its mineral reserves and production, and, most importantly, generate predictable returns for our gold sales.”

Unfortunately, when the market is roaring higher, a hedging program will also smooth the profits out in an up market – meaning the gold companies that have hedged their bets will not make nearly as much money as those that aren’t hedged.

As an investor looking to get the most bang for your buck out of gold, hedged gold stocks like Barrick and Anglogold are not your best choices. Yet these two stocks make up about 45% of the XAU Index – the inferior index. I consider the Amex Gold BUGS index (symbol ^HUI) a much better index to track…

The Amex Gold BUGS Index (the “BUGS” part actually is an acronym for Basket of Unhedged Gold Stocks) is much younger than the XAU Index, having started in 1996. It is a better gauge for how gold shares are acting in relation to the price of gold. The two major stocks in this index are Newmont Mining (NEM) and Goldcorp (GG). When you consider the fact that Newmont, the world’s #1 gold miner, only has a market value of $1.3 billion, you can see that the world of gold-mining is incredibly tiny. If you added up the value of every gold mining stock on the planet (roughly 2,000 companies), it would only come up to about half of what the tech stock Cisco trades for…

When gold’s day comes, an unhedged gold stock like Newmont could do extraordinarily well. Remember, the company is only valued at $1.3 billion. But get this: It has $419 million in cash! So the value of “the business” is closer to a tiny $880 million. This is a company with gold reserves of 87 million ounces – with a current value of nearly $30 billion dollars! Using Newmont as an example, the downside should be limited, due to its gold hoard in the ground. Yet the upside potential could be huge.

Gold Indices: Scrutinize Their Gold

You can use the standard analysis tools to analyze gold companies, as long as you complement your analysis with some scrutiny of their gold. With gold companies, you must also consider the cost per ounce of production and the state of gold reserves themselves. Cash costs of production at Newmont, for example, are expected to be around $200 an ounce in 2003. So gold, at $335, is nicely profitable. Reserves, again, are 87 million ounces.

The websites of Newmont, Barrick and AngloGold spell out all the details in their “analyst” and “investor relations” sections, including their hedging activity, their reserves, their costs per ounce, and more. Online, go to www.newmont.com, www.barrick.com, and www.anglogold.com, respectively.

Before investing in gold shares, start with these three websites to get your feet wet and gain an understanding of their businesses.

Then, when the time is right – when we see a clear uptrend in the Amex Gold BUGS Index – you may want to consider investing in an unhedged gold producer, like Newmont, Goldcorp, Kinross or another member of the Gold BUGS index.


Steve Sjuggerud, PhD.
for The Daily Reckoning
May 6, 2003


Curiouser and curiouser.

Day by day, we watch the quiet destruction of the dollar, the pain of it keeping us from gloating. We saw it coming, but we suffer along with everyone else. Yesterday’s lunch – – at 71 euros for a party of three – would have cost your editor about $62 a year ago. Now, it is close to $80.

The Canadian dollar rose to a 5-year high against the greenback yesterday. The euro hit a new 4-year high.

Back in the Homeland, who cares?

The Bush Administration talks about protecting the dollar, but would probably prefer to see the greenback decline in order to boost the competitiveness of U.S. products on world markets…while reducing America’s reliance on foreign capital.

The Fed, meanwhile, has practically guaranteed the dollar’s decline. Since dollars cost almost nothing to print, the Fed explained to an astonished world, it could produce as many as needed to drive the price down.

The curious part is that while the dollar falls on international currency markets, there is still little evidence of a big increase in consumer price inflation back home. Central bankers, we remind readers, do not take a malicious joy in killing their own currencies. They do so for practical reasons, not pure entertainment. A little inflation deceives people, encouraging consumers to spend money they don’t really have, and re-elect politicians they don’t really like.

But scanning the headlines, we see few favorable signs:

“War’s Quick End Produces No Economic Boom,” concludes the Associated Press.

“Recession Threat Still Looms,” notes TheStreet.com.

“Jobs scarce for grads,” adds the Chicago Tribune.

What have we become, my sweetish friends? What kind of mess have we gotten ourselves into? Neither war nor inflation seems to do the trick. The foreigners have gotten the message; the dollar sinks, just as the Fed intended. But so does the economy it hoped to rescue.

Eric, more details, please…


Eric Fry on Wall Street…

– The stock market took a breather yesterday, as the Dow slipped 51 points to 8,531. The hyperactive Nasdaq refused to rest, gaining 1 point to 1504. The high-tech index has rallied 35% from its closing low of 1,114 last October 9th.

– Sadly, the feeble dollar can’t keep up. The greenback tumbled another half a percent against the euro yesterday to $1.1287 – a new four-year low. If the dollar could hold its value for more than a day or two, we might be tempted to dislike U.S. stocks less. But as it is, the dollar’s weakness is yet one more reason to think twice about paying 30-plus times earnings for U.S. stocks.

– The greenback is crumbling like New Hampshire’s “Old Man of the Mountain.” We dollar-holders can thank the Old Man of the Federal Reserve for speeding the dollar’s selloff, and thereby eroding the purchasing power of our savings…No one said that “fighting deflation” would be painless.

– But who really cares about the dollar anyway? Stocks have been on a tear of late. In fact, the post-war rally has been so robust and has been going on for so long now that the Wall Street strategists – remember them? – have resumed showing up in public during daylight hours. They have also resumed chirping their mellifluous refrains about “second- half earnings recoveries” and “double-digit stock market gains for 2003.”

– Tobias Levkovich, institutional equity strategist at Smith Barney, thinks stocks are still a great value. His 2003 price target of 1,075 for the S&P 500 represents a gain of just over 15 percent from current levels.

– The perennially bullish Richard McCabe, Merrill Lynch’s chief market analyst, remains as perennially bullish as ever. He’s looking for a “major recovery or cyclical bull market,” which, we assume, will be even bigger and better than the various “major recoveries” and “bull markets” he has anticipated since 2000.

– Kevin Marder, chief market strategist at Ladenburg Thalmann Asset Management is also – yawn – bullish. He says that the Nasdaq came under “major accumulation” on two different days last week…That’s just gotta be bullish, right?

– Meanwhile, out on Main Street, the only items under “major accumulation” are pink slips. Outplacement firm Challenger Gray & Christmas reports that announced job cuts surged 71% in April from March’s levels due to a surge of layoffs in the public sector.

– Apparently, the budget crunch at state and local governments is starting to take its toll on the job market. As we’ve noted previously, the state governments will likely come up about $70 to $80 billion short this year. So it should come as little surprise that they might trim a few jobs.

– “While it doesn’t get all that much attention,” Barron’s recently noted, “the state-and-local sector accounts for 12% of GDP and 15% of this fair nation’s total employment. That’s more than either manufacturing or tech can lay claim to. And it’s one of the few sectors that had been growing. Since the start of the recession, Stephanie [Pomboy, editor of Macro Mavens] relates, states and locals added $85 billion to GDP and 300,000 jobs, helping to cushion the $140 billion shrinkage in capital investment and the loss of 2 million jobs suffered by the general economy during this stretch. But things have changed, bigtime and for the worse. The spur is fast becoming a serious drag.”

– And the private sector is unlikely to pick up the slack. “The sharp increase in job cuts last month should serve as a warning that it is premature to conclude that the quick end to the war in Iraq will bring a quick turnaround in the economy and job market,” said John Challenger, chief executive officer of the firm that bears his name.

– Emblematic of the tight labor market, technology jobs are becoming increasingly scarce. The Associated Press reports: “Demand for information technology positions ranging from software programmers to network engineers will hold steady or decline in the next 12 months, according to a telephone poll of 400 hiring managers by the Arlington, Va.-based Information Technology Association of America. – “The survey found there are about 493,000 unfilled technology jobs in the United States, down from 1.6 million open positions at the start of 2000…The tight market for technology jobs comes as hundreds of American companies outsource positions to smaller engineering and programming firms in India, China, Russia and other countries with inexpensive labor forces.” – Week by week, the economy shakes loose hundreds of thousands of jobs, like a dog scratching off fleas…So if you’re trudging through the stock market looking for capital gains, don’t look for any help from an improving labor market…that dog don’t hunt.


Bill Bonner, back in Paris…

*** Gold rose $1.30 yesterday. No comment. (At least from me…my friend Dr. Steve Sjuggerud has a few tips for the novice gold investor, below…).

*** What really happens when an Islamic terrorist blows himself up? Does he really go to heaven and pass his time in the company of “big-eyed virgins?” Or is the promise as empty as a campaign pledge?

Of course, we don’t know more than anyone else…for that is the borne from which no travelers return. And we wouldn’t have given the matter any thought at all had not Le Monde brought it up in this morning’s edition. It seems a German philologist, Christoph Luxenberg, has been retranslating the Koran. The work is not as straightforward as one might imagine, because it is not clear what dialect of Arabian it was written in. There were several. And the ancient Arab texts had no written vowels, which greatly increases the odds of getting something wrong. Luxenberg used a form of arabo-syriac for his translation and came up with very different results from the standard readings.

Instead of “big-eyed virgins,” the suicide bombers may end up with “fruit as white as crystal.” More important, Luxenberg says his translation shows that the Koran was intended as a selection of readings, meant to help explain the Bible, not to replace it.

*** “Dad, I know what I want to do now,” said Maria yesterday.

For the last 2 years, Maria has been home-schooled so that she could pursue a career as a model. Despite working at it diligently – she does 4 or 5 castings every day and has gotten a few very nice jobs – modeling no longer has the appeal it once did. Maria has spent too many hours standing in line…or waiting around for someone to take her photo…or doing whatever it is that models do. She’s getting neither rich nor famous. And so, the poor girl has been agonizing over her future. Maybe it is because she has so much of it to worry about.

“Modeling is just not what people think,” she went on. “I feel like I’m wasting my time. I think I’d rather go to a theater school.”

At 17, she is making a career change.

The Daily Reckoning