Saturday, November 22, 2008

Back to the fundamentals

Fundamentals are how we're supposed to invest, although technical analysis (i.e. tea leaf or chart reading) can be helpful to time entry and exit points. Gold stocks have the best fundamentals they have had in over two decades. Gold mining companies with operating mines that can generate cash flow and don't need to borrow money (since loans are now difficult to obtain) are in the best position they've been in for over 20 years. How do I know? The chart below, a ratio of gold divided by other commodities, tells me.

Gold mining companies dig gold (or real money as it's known to some) out of the ground. It's hard, labor-intensive and energy-intensive work. When the cost of digging money out of the ground drops, profit margins increase. In a deflationary environment, costs drop, because most commodities like oil as well as labor costs drop. For most companies, so does demand. However, cash (and real money [gold]) are in high demand in a deflationary environment because people are risk averse.

Thus, the gold mining companies have a product in high demand whose price is stable to rising while costs are going down. This means expanding profit margins and profits and that eventually translates into a higher stock price and often, higher dividends and dividend yields.

While other companies struggle to survive, gold mining companies are about to start making money hand over fist. Buy the ETF with ticker symbol GDX to get a diversified basket of senior mining stocks and start making some of that money. The 26% gain GDX had yesterday was just a taste of things to come. Gold miners are already making more money as we speak and earnings surprises will be to the upside for several quarters for producing gold mines.

All stocks are about to rally, but when the next brutal decline hits, it will be just a routine correction for gold stocks, which will now start to separate themselves from the general stock indices and become THE premier asset class for the next few years. This is not an inflation play, it is a deflation play, and the gains should be tremendous.

Wikinvest Wire