There are lots of reasons you should own some gold. Despite taking a recent breather, gold prices are still up by 139% in the last five years.
Even so, shares of gold mining stocks have suffered lately, hurt mainly by higher energy and exploration costs.
In fact, the stocks of the large gold miners have become nearly as undervalued as they were during the 2008 financial crisis.
The last time shares of these big gold producers were this cheap, they rallied by 283%.
At these levels, that means it's time to take a closer look at shares of big gold miners—while they are still a bargain.
Here's what you need to know. . .
The Gold Bull Market Is Not Over
A number of factors point to higher prices for gold:
- Real interest rates remain in negative territory. Sitting in cash right now is a losing proposition.
- The austerity movement in Europe is being replaced with more fiscal easing. The European Central Bank may have to print trillions of euros of debt to keep the Eurozone intact.
- The odds of more fiscal stimulus in China and the U.S. have increased, as two of the world's largest economies struggle to gain traction.
- Despite healthy demand and rising prices, global production of the metal rose just 0.7% annually from 1999 through 2011.
Combined with aggressive gold-buying binges by China and other foreign governments moving away from the U.S. dollar, the stage is set for the price of gold to rally.
Gold Mining Stocks Are Oversold
That is typically good for gold mining stocks.
But the two parted company in 2011. While spot gold moved higher for the 11th straight year, gaining 10%—gold stocks plunged by 16% last year.
That trend accelerated in 2012. After peaking at $1,900.03/ounce (oz) last September, gold bullion prices fell by roughly 21% to $1,486.
Meanwhile, gold stocks, as measured by the Market Vectors Gold Miners Fund (GDX:NYSEArca), plunged by as much as 41%.
In fact, the gap between the two has widened to almost historic highs.On May 1, gold stocks were trading 29% below where they normally would trade according to John Doody of the Gold Stock Analyst.
The only time these stocks have ever traded at a greater discount to gold was in the October 2008 crash, when they traded at a 34% discount.
On top of all that, sentiment surrounding the gold sector is extremely negative.
The Hulbert Gold Newsletter Sentiment Index, which measures the exposure recommended by short-term gold market timers was recently negative for 29 straight days—longer than any other stretch in history.
In other words, how investors view gold is about as negative as it can get.
"Gold traders' increasing impatience has led even more of them to throw in the towel—which, in turn, is why contrarians are confident that gold's next major move is most likely up," Mark Hulbert told Money News.
Bottom line: the upside potential for gold shares clearly outweighs the downside risk.
Gold mining stocks are badly oversold.
Prices Start to Rally
Meanwhile, gold stocks are finally starting to outperform the metal itself. GDX is up 15% in the past two weeks, even as spot prices have gained only 2.5%.
If gold prices bounce back to $1,900/oz, the index could nearly double.
Besides GDX, you may want to take a look at a few of the largest gold miners. These are well-diversified companies with a collection of mines in several countries to mitigate risk.
Shares of the world's second largest producer, Newmont Mining Corp. (NEM:NYSE), just bounced off its 52-week low and trade at just eight times projected 2013 earnings.
NEM pays a 2.9% dividend, tied to the price of gold. Newmont's profit went from $4.7 billion in 2009 to almost $6.5 billion in 2011. The price of gold contributes heavily to its bottom line.
The opportunity to invest in undervalued gold mining stocks is a rare occurrence in a gold bull market.
The last time it happened was four years ago and shares rose 283%. Take advantage while you can.