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Gold Sector: Current Situation and Per-Ounce Valuations

Steve Saville
Posted Dec 20, 2011

Below is an excerpt from a commentary originally posted at www.speculative-investor.com on 18th December 2011.

Current Market Situation

Last week's price action proved that the correction/consolidation in the gold sector that began in December of last year is still in progress. The following weekly XAU chart shows that it has been a 'water torture' type of correction in that the decline has been slow, but relentless.

We don't know when the next intermediate-term upward trend will commence. Nobody does. What we know is that sentiment is very depressed right now in both the gold sector of the stock market and the bullion market, which substantially mitigates downside risk. It is certainly possible that the XAU will test its early-October intra-day low of around 170 in the near future, but there won't be scope for it to trade significantly lower than that until after there is a long-enough and large-enough rally to inject a lot more optimism into the market.

It is important to understand that the situation near the beginning of the 2008 crash in the gold sector was very different to the current situation. In July of 2008 many people were anticipating -- and were thus positioned for -- a huge rally in inflation plays, despite the fact that monetary conditions were moderately tight at the time. Today there is a modicum of hope that the central banks will flood the financial system with money, but overall sentiment could not be more different. In July of 2008 there was considerable fear of inflation because it was wrongly believed that the Fed was already pumping money with abandon. Today there is hope that central banks will pump in order to avert economic weakness and deflation, even though the monetary inflation rate is already quite high and even though monetary inflation is one of the main reasons for the economic weakness.

In summary, in July of 2008 we had extreme enthusiasm for inflation plays in parallel with moderately tight monetary conditions, whereas today we have minimal enthusiasm for inflation plays in parallel with loose monetary conditions.

Moving along, a daily chart of Agnico Eagle (AEM) is displayed below. AEM's stock price tumbled from the mid-$50s to the low-$40s in October in reaction to news of an unexpected mine closure. It has since continued to slide and ended last week at $37.

It's likely that many AEM shareholders would view a rebound to former support at $50-$55 as an opportunity to get out, so this former support will probably act as impenetrable resistance for many months to come. However, the stock could easily rebound to the low-$50s during the next multi-week rally in the gold sector. It could therefore make a good short-term trade. The idea would be to accumulate a position at $37 or lower over the days ahead with the aim of exiting at around $50 during the first quarter of next year.

Per-ounce valuations for in-ground gold

We regularly see brokerage analysts and newsletter writers using $100/oz or even more when valuing the in-ground resources owned by junior gold mining companies. As explained by Danny Deadlock in a recent article, under present market conditions it will usually make no sense whatsoever to use such a high per-ounce valuation for the in-ground gold of an exploration-stage company or a small-scale producer.

Danny came up with an average current market valuation of $58/oz for junior gold mining stocks with at least 1M ounces of NI-43-101 resources. Furthermore, he showed that more than half the companies were being valued at less than $45/oz.

Our experience meshes with the results of Danny's analysis. In particular, we maintain a spreadsheet containing about 40 gold and silver mining stocks, about half of which are exploration-stage juniors. The in-ground gold resources of the exploration-stage juniors that we follow are presently getting valued by the market at an average of $30/oz.

It's reasonable to expect that per-ounce valuations will increase over the years ahead. In fact, it's reasonable to expect that at some stage there will be a massive upward re-valuation. However, in the current market environment it will usually not be appropriate to assign a value in excess of $50/oz to the in-ground resources of projects that are not yet in production. Currently, $20-$40/oz is normal.


Steve Saville
email: sas888_hk@yahoo.com
Hong Kong

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