Mind the Gap! Or Want to Buy Gold At USD 500 An Ounce?

Recent stock market declines resulting from the Euro Crisis and a lack of confidence in debt-ridden Western economies have caused opposite movements in the prices of gold and gold mining equities. Market-watchers Steve Hill and Nigel Ball reflect on how this may have created a buying opportunity for bargain hunters... 

As you're fully aware there has been a correction in the equity marketplace that was caused by the thing that investors hate most – uncertainty. The sluggish economic recovery in developed countries and downgrading of government credit ratings has caused much anxiety. More pressing is the concern over the future of the Greek economy and the country’s ability to stay with the other 16 countries in the Euro-zone, with further fears of the departure of the Spain, Portugal, Ireland and Italy. 

All this has caused a broad-based decline in equities. The MSCI World Stock Index of over 6000 stocks has dropped from 1391.86 on May 2nd to 1074.81 on October 3rd – almost a quarter of its value. Mining stocks have naturally taken a hit along with others all others with the MSCI World Mining Index dropping from 517.94 on April 13th to 327.41 on October 4th representing a decline of 36.8% - showing mining’s vulnerability to the economic cycle.

Counter to this gloom and decline and loss of confidence in “fiat” currencies that are not linked to gold. As a result the price of the yellow metal rose 12.83% in the 6 months to October 4th, and hit a record high of US$1923.70 on September 5th.

Gold mining company shares have come down in price with the other mining equities, but their worth is in their gold in the ground.  Proven – not estimated – reserves of many gold mining companies is down to approximately US$500 per ounce. 

As a result a gap has opened between the price of the metal and the mining companies, and this is clearly not historically sustainable. The two have been closely correlated over time, so the gap will surely be closed?in the near future. This is illustrated by the graph below, showing the close relationship between the two over the last years.

Consequently we believe gold stocks will recover to some extent and that gap closed, and could be a smart investment move.

And we’re not the only ones. 

The Qatari Royal family’s sovereign wealth fund plans to spend up to $US10 billion buying stakes in gold producers. The fund is seeking to invest in a range of natural resources, but gaining access to physical gold is its top strategic priority.

On October 2nd, Qatar Holdings, which handles the wealth of the Middle East state’s royal family, confirmed it would invest about $US1 billion in European Goldfields, a London-listed mining company currently developing the largest gold-mining project in Greece.

‘‘Qatar Holdings have done a systematic and detailed study of the gold sector,’’ said Ken Costa, who put the deal together. ‘‘They chose European Goldfields because [chairman] Martyn Konig is very experienced - a 30-year veteran in the gold market.’’

They are bargain hunting. For example European Goldfields, which they are buying into, is down 41 per cent in the year to date. This is despite the company receiving the long-awaited approval for mining from the Greek authorities in July.

The Qatari fund has acquired a 9.9 per cent stake in European Goldfields and is welcomed by the troubled Greek economy, and some 1500 jobs will be created as a result. Future likely targets for the Qataris are likely to be in Africa and Russia.

So as they say on the London Underground: “Mind The Gap”! 

This particular “gap” – between the price of physical gold and the gold producers which have been dragged down by overall market sentiment, could be good news for mining companies and for investors holding and of course for bargain hunters buying mining stocks or funds. 

“When others are greedy, be fearful, and when others are fearful, be greedy.” – Warren Buffett.