Another Day for Gold?

05/26/2006 12:00 am EST


Adrian Day

Chairman and CEO, Adrian Day Asset Management

Is the recent downmove in gold the end of the bull market? Adrian Day, one of the industry's most respected authorities on natural resources says, "We shouldn’t be very surprised at the recent decline; gold had simply moved too far, too fast." Here’s his outlook.

"Given gold’s strength since the end of March, a retreat was to be expected and a period of consolidation likely. We saw the same sort of panic reaction in early December, when gold tumbled from $542 to $489; oh, how long ago those prices seem and that correction proved to be a mere blip on the graph! Those who sold then have been regretting it since. So, I’ll say what I said: don’t panic!

"In my opinion, gold’s longer-term bull market is still very much intact. Some consolidation is still likely, but I doubt it will be very long or deep (though probably longer and deeper than December’s). Overall, this correction offers opportunities to accumulate more quality gold stocks

"First, gold’s bull market is still alive. The macroeconomic environment (global economic growth; low real interest rates; inflation pointing up) favors gold. The dollar rally is over and a long-term decline is likely (for reasons that are well known: twin deficits; slow down in foreign buying; and foreign bank diversification).

"The latest statistics show a collapse in net foreign buying of US securities, and net foreign selling by central banks for the first time in over three years. Several countries have been reducing US holdings; Sweden has sold a significant part of its dollar reserves; Qatar has said it will reduce new buying of dollars; Russia has said it is inappropriate for the dollar to be the only global reserve currency; And Chinese bank officials have also said they see the need to diversify with new reserves.

"The geopolitical situation remains uncertain, despite the recent movement on Iran’s nuclear issue. China’s economy remains healthy, with growth around 10% and low inflation. Investment demand for gold has been increasing over the past several months, with physical buying from the Mid-East in particular, and increased inflows into the gold ETFs.

"Meanwhile, gold remains inexpensive and there isn’t enough of it. As for supply, we know that global mine production has been stagnant, and that it is becoming increasingly difficult (and protracted) for major companies to find major deposits, and to explore,develop, and mine them (think Venezuela, Romania and Montana, among other jurisdictions).

"Finally, despite the recent rapid increase in the gold price, it remains on an historical basis still undervalued relative to other assets in varying degrees: to its long-term inflation-adjusted price; to the money supply; to stocks and financial assets; and to oil, among other comparisons. And the gold stocks themselves are selling at only average valuations on most metrics (cash flow, reserves, production, and so forth). So we are by no means anywhere near the speculative top for gold and gold stocks, only a near-term and temporary peak.

"How long might this correction last and how low will it take prices? One can never be sure. Corrections can often be worse than expected, and in the current circumstances prices have moved very fast, and well above trend, so a period of weeks of consolidation would not be unexpected nor would it disturb the long-term bullish trend. Just as recent prices were driven partly by follow-the-leader hedge fund buying, so too can we expect some fund liquidation.

"My preferred approach to the sector is this: While avoiding the temptation to try to catch the falling knife, buying stocks just because they are down from their peaks—16% on average in the past week—one should look for opportunities to accumulate good quality companies at reasonable valuations, so one is prepared when the markets turn. All too often, waiting until stocks have turned means missing out on some of the best moves.

"Is this the time to buy? Everyone is in a different circumstance—some are loaded up the gills with gold and resource stocks and others have none. I consider Virginia Gold (CA:VGQ Toronto) to be a very strong buy, which means that you can buy even if you already own. Silver Wheaton (SLW ASE), Silver Standard (SSRI NASDAQ), and Orezone (OZN ASE) are strong buy, which means you should buy if you are underweight the sector or individual stocks. Newmont (NEM NYSE) is a buy, which implies that if you are very underweight the sector this is not a bad price at which to buy, but there’s no need to buy aggressively. Again, we may see further weakness so don’t use all your powder in one shot."

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