Get Ready For Gold's Rebound
Curtis Hesler, Professional Timing Service, 05.26.05, 2:40 PM ET
 

MISSOULA, MONT. - The Philadelphia Gold and Silver Index and the Gold Bugs Index both topped out last November at about 30% higher than they are presently. These corrections in the metals can be brutal, but there is little evidence in my technical work that the bull market in commodities--or in precious metals specifically--is over. In fact, it appears that the correction has all but run its course, and the next significant move will be to the up side.

How far? I fully expect to see new highs in gold by year's end. The next sticking point will be $500 in bullion. However, it is important to recognize the leverage factor inherent between the price of gold and the profitability of gold-mining companies.

Essentially, if a mine produces gold for $300 per ounce and gold sells for $300 per ounce, they are obviously at break-even. Every dollar that gold rises from that point falls directly to the bottom line as profit--hence the leverage and the reason gold shares tend to be more volatile than bullion.

The price of gold is also reflected in the value of the mine's reserves and inventory of bullion if they tend to hold back production, as Goldcorp (nyse: GG - news - people ) does. A higher price of gold means the mining company's assets are worth more.

So, there should be a relationship between the price of gold and the price of gold-mining shares. This relationship is most evident between the price of gold and the price of gold-mining averages, like the Philadelphia Gold and Silver Index ( XAU) and Gold Bugs Index ( HUI) .

If you divide the price of gold by the price of the XAU, you will see this relationship as the gold\XAU ratio. The ratio cycles between four times on the low side when mining stocks are relatively expensive compared with the price of gold and five on the up side when precious metal shares are inexpensive relative to the price of gold.

The dollar plays into this in that gold bullion prices tend to move opposite to the value of the U.S. dollar. The dollar index has been gradually rising since reaching a low last December, and this has put a damper on the price of gold bullion. However, gold has held up fairly well, only falling about 9.5% from its December high. The real damage has been in the mining shares.

This has recently put the gold/XAU ratio at 5.25. Rarely do you see it over 5.50, which is a screaming buy signal for gold shares. There may or may not be additional weakness in the mining stocks and XAU; but in the past when the ratio has hit 5.25 or higher, gold stocks were a screaming buy.

Incidentally, my work in the dollar is turning negative also and that bodes well for higher gold prices this summer. I believe the next leg in the commodity bull market will take gold to $500.

What to buy? I like Yamana (amex: AUY - news - people ) and Western Silver (amex: WTZ - news - people ) from my list of junior mining stocks. There is an interesting longer shot in Mines Management (amex: MGN - news - people ). They are developing a silver mine just north of Missoula, Mont., where I live. It will be two years yet until this mine begins production, but it will likely be one of the largest silver mines in the world.

As for the major producers, I like Newmont Mining (nyse: NEM - news - people ), regardless of their recent earnings woes. They will work this problem out, and they tend to be an institutional favorite. In the next gold run, you will see precious metals being taken more seriously by a wider segment of investors, including institutions.

Here is a bit of a surprise--Anglogold Ashanti (nyse: AU - news - people ). They have been very strong lately, leading the pack, so to speak.

The juniors could easily double from here. Newmont had a high of $49.98, and Anglo hit $42.40 last November. I expect both of these to surpass those highs in the next bull leg.

The commodity bull is not over--far from it. China and India, together with nearly two billion souls, will become the largest consumers of commodities, including energy, gold, silver and everything else. If you have a few dollars to invest in precious metals, you will rarely find a time when the mining stocks are this cheap.

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