Gold Stock Fundamentals

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"Regarding gold stocks, talk of inflation or deflation misses the point."

Most of the mainstream media seems cautiously bullish on gold yet they offer no position on the gold stocks. While the stocks are well off their highs, there are several key positive developments for the sector.

Relatively speaking, it is clear that a new bull market in the gold stocks is underway. As I have learned, a rising gold price isn't what matters for this sector. Gold stocks outperform or underperform based on the relationship between the price of gold and their various costs. Gold stocks underperformed from 2004 to 2008 because their costs were rising in tandem with price inflation and commodity prices.

Recently, gold has soared against anything other than Treasuries, Dollars and Yen. This includes the cost inputs of mining, such as oil and steel. From 2001 to 2003 when gold stocks outperformed gold, gold was advancing against oil, base metals and commodities. Gold stocks had leverage to gold because gold was rising faster than cost inputs. From 2004 to 2008, gold fell against oil and base metals while trending sideways against commodities. Thus, the gold stocks underperformed as their cost inputs rose too quickly.

The action in the currency markets, namely a strong dollar, is also boosting the margins of the gold producers. As most mining and exploration occurs outside of the U.S., a strong dollar equates to weaker local currencies, which means lower costs. Essentially, if you are a gold company operating outside of the U.S., strong gold and a strong dollar benefits you the most.

Regarding gold stocks, talk of inflation or deflation misses the point. What matters most are the local price of gold and the relative price of gold (gold against its cost inputs). Since March of 2008 when the HUI peaked at 519, the local price of gold in every case except for the U.S. and Japan has advanced to new all-time highs.

Meanwhile, even though the official and U.S. price is 14% off its high, mining input costs have fallen much farther. The gold stocks, at 40% off their highs, are clearly undervalued. Should gold blast through $1,000/oz without the help of a falling dollar or an inflationary tide (in which everything rises), then the gold stocks will be primed for a violent advance.

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