GOLD RATIOS: BEARISH FOR GOLD PRICES, BULLISH FOR GOLD SHARES
by Ed Bugos

I dropped in on the Cambridge House gold show in Vancouver this weekend. It was busy. People were generally upbeat and felt smart about the bargains they loaded up on during the recent rout.

The analysts were confident about valuations going forward, especially long term. Company execs swore their deals didn't need any money, while brokers and bankers alike had a gleam in their eye about the financing opportunities amid the debris – even a sense of urgency. One broker – my former business partner, actually – wondered whether the fundamentals for gold have ever been as bullish in our lives.

The answer was unambiguous. The market has answered too.

Newmont and Freeport this week filed documents in conjunction with potential underwritings by J.P. Morgan and Citigroup, in the amounts of $1.2 billion and $750 million, respectively, totaling just under $2 billion. Kinross sold UBS about $400 million worth of stock last week. Lundin's Red Back also negotiated a bought deal worth about $150 million with a group of underwriters led by Cormark Securities and BMO last week. Earlier this month, Yamana closed a $135 million share offer and borrowed $200 million, while in December, Agnico-Eagle raised some $300 million from stock issuances after borrowing $300 million a few months earlier (in September). Where's the deflation?!

The money is coming into the gold sector. The Canadian National Post reported last week that gold miners are “raising cash with ease... many generalist funds have jumped onto the precious metals bandwagon.”

Many juniors have also reported financings where needed. Some are turning them away. Share issues are just too dilutive down here, and any company that doesn't need money to survive 2009 is prudent to refuse.

Asked about the ability of miners to raise cash in this environment, the analysts at the podium at the Cambridge House investment conference in Vancouver all agreed there is always funding for assets that have sound economic fundamentals. They finance themselves.

In fact, in my experience, it is often better to buy the shares of companies with good assets that need cash than companies with cash and no assets, even if the latter are trading at a discount to cash breakup, and even if funding is relatively scarce. Companies with a lot of cash can sometimes get lazy and put up their feet, or insiders waste it – or even steal it, if they lack integrity.

Cash itself yields nothing. It's a depreciating good, as you know. It's one thing to buy a company at below cash breakup and then break it up and keep the extra cash. It is another thing to invest in a company at cash breakup or less. We invest to earn profits.

If you want to buy cash at a discount, buy a T-bill or term deposit. Or else, you're just sharing in potential losses due to debasement, negligence, debauchery or theft. That doesn't mean you should avoid the deals that have a lot of cash – just that's not what you're investing in. You are investing either in the underlying asset, which yields profit (i.e., more cash in the future) or management's abilities.

Ultimately, sound “assets” will hold their value better than idle cash in an inflationary environment.

It is obvious that through this crisis, despite some turbulence, gold prices have held up better than just about any other asset, commodity or currency (other than dollars and yen) we may imagine. From the point of view of a gold miner, this is a very good thing.

Even better is that the price of oil, a significant cost input for miners, has fallen a lot relative to gold. This is bullish for margins. Also bullish for gold miners is that the slump may have freed up capital and labor for the development of gold assets, where previous scarcity drove up capex estimates so much that some projects had to be abandoned.

The combination of strong investment demand for gold and lower input costs makes gold stocks one of the only sectors poised for any growth in operating results (i.e., earnings and cash flows) in 2009.

On the other hand, the ratio of gold prices to many of the commodities, and the averages, is at more than a 10-year extreme, and it is not sustainable. As a matter of fact, I think it could be a drag on gold prices. Gold is the only commodity challenging the resistance point in its post-March 2008 downtrend.

It looks poised to break out, and the other commodities appear to be bottoming.

However, while the extremity lasts, it could cap gold prices.

My feeling is that the gold ratios (i.e., gold prices relative to other assets, commodities and currencies) are going to ebb in the short term while commodity prices catch up a little. I continue to think that this catch-up phase will include a rally in stock prices, and a general recovery in risk appetite, even if short-lived. While it lasts, it is likely to shave a few safe-haven points off gold. It hasn't started yet.

I'm not looking for new lows in gold on this... just some backfilling and consolidation while the other commodities and assets catch up some. This could happen over the next few months. Then look out.

Regardless, however, I expect gold shares to benefit from the general return of risk appetite too.

That is, but for some ebb and flow, I expect gold shares to do well whether gold goes up or not – so long as it doesn't go down too much. As long as it holds the $800-850 level, gold shares are a buy.

It is still a buyer's market. Many gold shares are still factoring in a gold price of less than $800. But don't be hasty.

Rather, be deliberate, which means don't waver from the plan or your conviction on dips. Buy them. Try not to buy on days when everyone else is, like today, but make sure you have a shopping list and just pick away at it when you get the dip.

Investors should always wade in (and out) of their positions, rather than jumping in and out – as ole Jesse Livermore used to do. They called him the “Boy Plunger.” He made big on the way up and lost big on the way down. There are lots of folks like that on Wall Street. They're big gamblers. You could say the Fed made them. They don't care about the black swan, because they believe that should they lose, they will just win again tomorrow.

Keep in mind, though, you're not buying blue chips here. Small-cap miners (and options) are extremely volatile and risky.

Remember this is for 10-20% of your financial assets – whatever you can sleep at night with. Some people can sleep with more – some can't sleep anyway. I guess the analogy doesn't apply to insomniacs, but you get the gist.

Good trading,

Ed Bugos