10-year Strategy of Buying Gold Stocks When Gold Bullion Moves Lower in Price Still Working

There is one strategy investors have (or at least this investor has) been following for 10 years to make money in this treacherous market.

The strategy is quite elementary. Every time the price of gold bullion moves down three percent, I like to go in and buy more gold-related investments. This strategy has worked for 10 years and I still see the opportunity continuing in buying gold stocks when the yellow metal has sharp, one-day corrections.

I need to tell you, dear reader, I laugh when I read reports try to explain why the price of gold bullion is falling or rising. Yesterday, a well-known financial site said that gold bullion was down sharply, because rating agency Fitch said that big U.S. banks could see their credit ratings downgraded because of their exposure to the eurozone’s debt crisis. How ridiculous.

It doesn’t matter to me why gold bullion prices are rising or falling on a daily basis. What matters to me is the long-term direction of the financial markets. We know that the Federal Reserve initiated an unprecedented expansion of the money supply in the U.S. over the past three years. We also know that many eurozone members need a big bailout from the European Central Bank. The numbers I have read say that the financially challenged eurozone countries need a $2.0-trillion bailout.

The bottom line: the more fiat money created in America or Europe, the less the value of money, the greater the risk of inflation, and the higher the price of gold bullion goes. (See Top Five Reasons Why Gold Bullion Prices Will Move Even Higher.)

The real reason gold bullion goes up or down daily? I believe investors and traders are simply taking the opportunity to take some profits off the table. As gold bullion prices decline, gold bugs move in and buy more, pushing the prices of gold stocks up.

Yesterday, the December gold futures contract fell $54.40 to $1,719.90 an ounce…what an opportunity for investors to jump in and buy more momentarily depressed gold stocks! And talking about gold stocks, I was very impressed Thursday that, in spite of gold bullion being down three percent for the day, gold stocks did not collapse as they normally would on a day where gold bullion is down over $50.00 an ounce.

While I’ll talk more about this next week, world central banks bought more gold bullion in the third quarter ended September 30, 2011 than in any other quarter in the past 10 years! I wonder why central banks are suddenly running out and buying gold? Must be all those issues of PROFIT CONFIDENTIAL (10 years of them) where I’ve been pushing gold-related investments.

Next week, I will be writing more about the recent actions of world central banks rushing out to buy gold.

The Gold Stock at the Top of My List

After the tech bubble in March 2000 popped and before the recent financial and credit crises struck, at least three sectors have managed to post significant gains: bonds; real estate; and small-caps. For some reason, however, gold remained under the radar for most investors. Yet, since the stock market peak, prices have climbed past many psychological marks. The shares of companies that mine the metal have gone for the ride.

The perennial question for any gold investor is whether to buy bullion or gold mining stocks. I favor gold stocks over the higher risk of other commodity options.

While generally favoring gold stocks, I view Newmont Mining Corporation (NYSE/NEM) in particular as a really good investment, because we see this stock bringing value to your portfolio for years to come.

Without a doubt, for those investors looking to hedge their portfolios with gold exposure, Newmont Mining deserves to be at the top of the list. This company stands out among other players for two reasons: 1) size; and 2) low production costs, even in the rising price environment.

Over the years, Newmont has grown rapidly through mergers and acquisitions, as well as the development of its existing reserves. This strategy resulted in the company’s diversified risks; namely, unlike junior producers, Newmont doesn’t depend on one or two of its mines for its future and it is certainly not exposed to politically unstable regions.

In that regard, the risk is spread out, as the company continues to maintain an aggressive worldwide exploration program and is actively participating in and taking advantage of the ongoing industry consolidations.

In terms of costs, Newmont enjoys an overall favorable cost structure, although the recent quarter painted a very bleak picture when it came to capital expenditures. Its South American operations are the major factor in keeping the company’s costs down. This is particularly true with the Yanacocha property in Peru, where cash costs are in the lowest per-ounce price range.

The company’s diversified portfolio of low-cost mines allows it to remain profitable, even during prolonged weakness in the gold bullion market. In the past 10 years, Newmont has posted net losses three times; yet each year it has generated positive operating cash flows.

Over the past five years, Newmont’s investment rate has been around 60% (the investment rate is the percentage of profits the company has returned back to its business operations).

This strategy is consistent with what most producers do; return every dollar earned, and then some, back into the operations. However, with Newmont, it seems to come with ease, adding further to its attractiveness, as it can grow even during periods of depressed gold prices and at a lower investment rate.

Newmont’s cash flows are highly sensitive to the price of gold, because the company remains largely unhedged, thus exposing itself to the whims of the gold market. However, market data and the current economic environment suggest that the gold market is dancing with the bulls, so the company’s unhedged strategy promises profits, as the price of gold rises further.

This is the stock that saw its market price go up double percentage points over the past three years and its sales double every three years. The company is growing aggressively—both internally and by acquisitions—and has sufficient cash in the bank to finance that growth.

Newmont Mining appears to be the perfect choice for investors looking for a company with excellent fundamentals, a proven track record, and experienced and knowledgeable management. Note that this is not a recommendation necessarily to buy the stock right now, but you should definitely take a look at it.

Newmont is a leader in gold. In technology, a company that has fallen on hard times, but that I feel is set for fresh growth is Microsoft, which you can read about in Microsoft May Be Set for Prime Time.

Forget the Economy; These Companies Are Still Earning Big Money

Gold Investment Guide

Alcoa, Inc. (NYSE/AA), the first stock in the Dow Jones Industrial Average to report third-quarter earnings, missed analyst expectations. The Street was hoping Alcoa would earn about $0.20 a share. The company earned $0.15 a share. But let’s look closer.

Alcoa’s net income in the third quarter of this year more than doubled to $172 million from only $61.0 million last year; nothing to sneeze at.Gold Investment Guide

And if we look even closer, we see that the world’s largest aluminum company is reflective of other large American companies. Alcoa, after posting consecutive quarterly losses in late 2008 and into 2009, slashed 20,000 jobs and closed non-profitable smelters. It cut costs, focused on profitability. And the profits started to roll in.

What the market wants is fast, big growth. We had that in 2009 and 2010. Company profits across the 30 large Dow Jones components have been very strong over the past two years.

Analysts are expecting the S&P 500 companies to report a 14% increase in third-quarter profits. Sure, that’s the slowest pace since late 2009 and a lot lower than the 19% growth in the earnings these companies experienced in the second quarter of 2001, but again, nothing to sneeze at. I think it’s steady and healthy earnings growth.

Corporate America has $2.0 trillion socked away in their coffers. That number will grow as these companies continue to post double-digit earnings growth. We’ll be surprised at how well corporate America will fare the remainder of this year even as the U.S. economy continues to deteriorate.

Michael’s Personal Notes:

September 2011 was the worst month for gold bullion prices in about three years. Gold was down 10% in price in September, which equates to almost $200.00 an ounce.

I want my readers to know that a 10% correction in gold bullion prices is not a big deal…and that a healthier correction would have been in the 15% to 20% range. Such a decline in gold prices would serve to drive speculators and “weak hands” from the gold bull market that started in 2001.

Is the price correction in the ongoing bull market in gold over? I hope so. But I wouldn’t be surprised to see some back-filling…some more downside before gold bullion makes a serious attempt to break through the $2,000 an ounce mark.

I would have been more comfortable if gold bullion prices broke down towards $1,500 an ounce in the recent correction—the metal only reached a low of $1,598 per ounce on September 26, 2011, before moving back up.

My message: I wouldn’t be surprised to see gold prices pull back again. I’m not convinced the correction is over.

Where the Market Stands, Where it’s Headed:

In October of 2007, after a 20-plus year bull market, a bear market was born. Phase I of that bear market brought stocks to a 12-year low on March 9, 2009. On that date, we entered Phase II of the bear market, a period in which stocks rise as the bear attempts to lure investors back into the stock market. This is where we are.

Phase II of secular bear markets tend to last years. With the 1934-1937 bear market rally, the duration was 35 months. So far, we’ve been in this Phase II bear market for 31 months. I believe that stock prices will mover higher before this Phase II bear market rally is over.

Phase III of the bear market will see stock prices approach their March 2009 level, possibly breaking below them and creating new multi-year price lows.

What He Said:

“Any way you look at it, the U.S. housing market is in for a real beating. As I have written before, in the late 1920s, the real estate market crashed first, the stock market second, and the economy third. This is the exact sequence of events I believe we are witnessing 80 years later.” Michael Lombardi in PROFIT CONFIDENTIAL, August 27, 2007. “As for the stock market, it continues along its merry way, oblivious to what is happening to homebuyers’ wealth. (Since 2005, I have been writing about how the real estate bust would be bigger than the boom.) In 1927, the real estate market crashed and the stock market, even back then, carried along its merry way for two more years until it eventually crashed. History has a way of repeating itself.” Michael Lombardi in PROFIT CONFIDENTIAL, November 21, 2007. Dire predictions that came true.