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Gold GDX Has Given Us a Nice Secondary Buy Point

Commodities / Gold and Silver 2011 Sep 21, 2011 - 01:39 AM GMT

By: George_Maniere


Best Financial Markets Analysis ArticleThere has been a growing numbers of investing experts have been declaring that gold is a bubble: an insanely overvalued asset whose price is bound to burst.

I believe that there is no basis for that opinion. Understanding why I feel this way can help point an investor toward clearer thinking about the frenzied precious metal markets.

I agree that gold seems expensive. At its recent price of $1,813 an ounce, gold is off only slightly from the record high of $1,912 touched on Sept. 6. Gold is up more than 40% over the past year, largely on fears that paper currencies like the dollar won't retain their value.

While many investors are saying that gold is overvalued I do not agree. Until the central banks stop the printing of fiat money the price of gold will continue to rise. There are people who say gold is in a bubble. This is not something I agree with. A bubble occurs when the price of the underlying asset is not supported by the value of the asset. As long as the central banks continue to print fiat paper currency I think gold is heading for $2,500, $5,000 or even $10,000 an ounce.

What the teachings of Martin Armstrong have taught us is that gold is the mean or the standard around which all currencies dance or float as they are worth more in times of deflation (like now) and less in times of inflation.

I don't know how to determine the fundamental value of gold and I don’t believe anyone else who can but there is one aspect of gold investing where it is possible to make rational estimates of value. The stocks of gold-mining companies by historical standards seem cheap. This is based not on subjective forecasts of continuing printing of fiat paper money but rather on objective measures of stock-market valuation.

I believe we haven't seen low valuations like this since 2008. Financially, gold miners have never been in better shape. A look at the Market Vectors Gold Miners exchange-traded fund (GDX) which holds 30 gold mining stocks will bear out this thesis.

Several big gold-mining companies—among them, Barrick Gold (ABX) and Newmont Mining (NEM)—are trading around 14 times their earnings over the past four quarters, virtually matching the Standard & Poor's 500-stock index ($SPX) at 14.5 times earnings. Even with gold at record highs, the shares of gold miners are trading at an industry wide average of roughly 18 times earnings, at 2.4 times book or asset value (versus 2.0 times for the overall stock market) and at one of the lowest ratios on record to the price of the metal itself. Yet mining companies have rarely if ever been more profitable, and should be able to generate high returns so long as gold stays above $1,500 or $1,600.

Gold stocks aren't a low-risk play. Like the metal itself, they can burn you, especially if you expect to get rich quick. Gold mining has been the classic boom-bust industry, with managements squandering money on acquisitions and bad investments during the fat years and retrenching during the lean years. This is why I recommend buying the GDX ETF. GDX holds 30 of the top gold mining companies in the world. The risk of a bad move by one company is spread out so a bad decision by one company is spread out. I only see upside potential in the GDX.

Please see the chart below.

As you can see from this chart GDX had a hard time breaking the $55.00 level. I can only assume that this was due to the human emotion that people would rather hold gold above the ground rather than hold real wealth in the ground.

Once GDX broke $55.00 it ran up to over $60.00 and gave $55.00 one more test but then moved quickly up along with the price of gold. This is because the valuations of extracting gold from the ground were so compelling that the miners finally had their day. With the average cost of extracting and ounce of gold from the ground at under $900.00 the margins are simply too compelling to ignore.

I believe that GDX has given us a nice secondary buy point – one we are not likely to see again. If you do not yet have a position in GDX I suggest you open a small position here and wait because gold may still pull back a bit more. If you can buy this ETF for $62.00 or less it’s a great buy and I will be adding to my position if it pulls back to that level.

By George Maniere

In 2004, after retiring from a very successful building career, I became determined to learn all I could about the stock market. In 2009, I knew the market was seriously oversold and committed a serious amount of capital to the market. Needless to say things went quite nicely but I always remebered 2 important things. Hubris equals failure and the market can remain illogical longer than you can remain solvent. Please post all comments and questions. Please feel free to email me at I will respond.

© 2011 Copyright George Maniere - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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