Time to Buy Gold Stocks

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Gold stocks previously looked unappealing in a world of high and rising production costs, subdued inflation expectations, and wanton disregard for risk. All those factors look set to shift.

Up until now -- that is, up until a few weeks ago -- upside for gold stocks was capped by at least three negative perceptions...Modest inflation expectations, high and rising production costs and better alternatives in a rosy environment...

Now consider the outlook ahead for gold stocks... particularly the possibility that all three factors could soon be turned around.. Let's revisit each in turn:

Rising inflation expectations. Seeing the worth of Wall Street's assurances, does anyone trust the word "contained" anymore? When various central banks are forced to continue injecting liquidity into the system -- and when the Fed is finally forced to cut rates -- the growing problem of inflation could reveal itself to all. (A diving dollar could underscore this also.) The general best-case scenario, we suspect, is one in which inflation rises quickly but not too quickly. The worst case scenario is a deflationary downward spiral... in which case "Helicopter Ben" earns his nickname, and gold becomes the only stable proxy for cash.

Flatlining, or even declining, production costs. The high price of crude oil is a function of supply and demand; more specifically, it is a function of the "lack of slack" between daily global supply and daily global demand. This means that oil is priced at the margins; any increase or decrease in the amount of slack could have powerful psychological effect. A short-term decline in demand, from the United States or elsewhere, could open enough slack in the system for the price of oil to fall. Oil will eventually just go back up again, of course, as world demand always comes back around. But if the global economy takes a breather, we could see temporarily lower energy prices and lower base metal demand. This relief could lead to lower production costs for gold miners -- fuel not so expensive, labor not so tight, truck tires not so hard to find etcetera -- even as general inflation expectations rise due to stimulus as noted above.

More focus on risk in an uncertain environment.In an uncertain world with storm clouds on the horizon, gold takes on a new luster. If investors express a desire to stay in equities but avoid financial tomfoolery, they could well focus on the sectors and industries that are "derivatives-free," featuring straight forward companies with unleveraged balance sheets. Gold mining can be an ugly business, but it's a solid one that the public (and institutionals) can understand...

So that about sums it up. Gold stocks previously looked unappealing in a world of high and rising production costs, subdued inflation expectations, and wanton disregard for risk. All those factors look set to shift.

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