(12/21/11) A Seemingly Insane Gold Play

When it comes to contrarian thinking, this one is near the top of the list, says Jack Adamo of Insiders Plus.

With gold falling again, I’m getting subscriber inquiries about whether it’s time to bail out on the yellow metal. My answer is no, but bears some elaboration.

I fully expect gold to fall between 12% and 20% from here, possibly more. Gold mining stocks will probably get hit worse. But our exposure is relatively small for my taste, with only 17% of the Main Portfolio in gold, and none of the High Income Portfolio. If you recall, we’ve had the Main Portfolio as high as 32% invested in gold.

The last ten years has taught me that getting back into gold at the right time is difficult, and staying in has been the right choice in the long run. I think I’m much better at reading the market now, and I’m applying those insights to the market as a whole, but I think it is unnecessary with gold, given its superior performance and prospects.

Gold is actually oversold in the short term. If we were in a typical market, I would expect a bounce from here, but statistical trades based on overbought-oversold conditions, 3% envelopes, etc. fail during longer-term changes in direction.

The Commitments Of Traders Report also does not look bullish, and the long-term charts for gold are on the cusp of falling into a pullback similar to 2008’s. Hence my expectation of a drop of up to 20%.

You probably think I’m crazy recommending a new gold position after all I’ve just said, and you’ll think I’m even crazier when I confess I don’t like this company very much. But if the price is right, almost anything can be a good investment.

We owned Agnico-Eagle Mines Ltd. (AEM) for a while, until its options issuance got out of hand. And although the company gets high marks on some matters of investor stewardship, I’m also not a fan of the company’s tendency to gloss over some of its problems.

That said, the stock is just too cheap now. Probably due to year-end tax selling after getting creamed this year, it is still falling and may continue to do so for the next couple of weeks, but I want to dip a toe in now. It is down nearly 60% in the last year.

At this price, it could get a write-up in Barron’s or get on Goldman’s conviction list and pop 15% overnight. If it continues to fall—even another 20% or more—I’m fine with that. Two years from now it should all be money well spent. We will buy more on any significant pullbacks.

The short story (remember, I’m on vacation) is that the company is having trouble at two of its big mines. That will slow production and lift average costs, reining in expected EPS growth for the coming year. However, the company should still bring in $3 for 2012, assuming gold stays above $1,250, which is a pretty safe bet.

The stock is selling at about 12 times 2012 expected earnings—by far the cheapest of the group. But even if AE misses estimates, the following three years should see gold prices soar as the Fed’s money printing works overtime to pay off our country’s approaching grand parade of unfunded liabilities. Meanwhile, several other of the company’s mining projects should come on line, lifting earnings 15% to 20% for a few years running.

I should also mention that all of Agnico-Eagle’s mines are in countries that are politically very stable. That may be very important in coming years as South and Central American countries swing back to the political Left. Buy Agnico-Eagle Mines Ltd. up to $40.

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