What Would $5,800 Gold Mean for Junior Miners?

The Aden sisters, Mary Anne and Pamela, have extrapolated the future price of gold using the same growth rate as in the ‘70s, applied it to the current bull market and have determined that if one were to compare the bull market’s second rise from 1976 to 1980 to the current bull market we could see gold eventually reach $4,100 during the next run-up and that if one were to take the entire bull market gain in the 1970s and extrapolate it to today’s situation then $5,800 would be the equivalent upside target.

The Adens believe that “with today’s bull market being far more global in scope compared to the 1970s, we could eventually see these much higher gold price targets realized. This is especially so factoring in that gold’s peak in 1980 at $850 is the equivalent of about $2,400 in current dollars. Gold has not even approached that level yet and the situation is far more serious now than it was then.”

And silver? “Silver is more volatile than gold. It fell more than gold last year, and it has risen more than gold this year. This makes sense because silver is both a precious and a base metal. To foresee silver’s potential compared to gold, look to copper as a guide. Copper is a good barometer because it rises during times of global economic growth. That is, when you see both gold and copper rising together, then silver will most likely be stronger than gold… If global growth remains on a positive track, we will continue to see silver outperform gold.” And such is holding true today.

I mentioned in a previous exclusive article for Kitco that “we are in the eye of the storm and when the other side of the vortex engulfs us gold and silver will increase considerably, their associated stocks will go up substantially and their warrants, where available, will escalate dramatically”. So what can we expect in the price of gold and silver equities should “considerably” be replaced with the reality of gold prices escalating to somewhere between $4,100 and $5,800 in the near future?

Well, the stocks of the 22 companies in our proprietary Gold and Silver Companies Index (GSCI) have appreciated by 215% from their 52-week lows in 2008. In addition, the 24+ month duration warrants of those 22 companies (26 in total) in our Precious Metals Warrants Index (PMWI) have already gone up 445%. That is correct: 445%. During the same period gold has gone up 49% from its low of $705. Talk about leverage. That represents a 4.4 times greater increase for such stocks and 9.1 greater increase for their associated warrants. Very impressive!

As the table below shows, the average large cap gold and/or silver mining/royalty company, as represented by the HUI, is up 2.2 times that of gold bullion YTD while the micro/nano cap companies, as represented by the CDNX, are up 4.9 times that of gold bullion YTD. Carrying that comparison one step further, those gold and silver companies in the Gold and Silver Companies Index (GSCI) are up 3.3 times that of gold bullion YTD and their associated warrants (PMWI) up by 4.8 times that of gold bullion YTD. Therein lays the advantage of investing in the shares and/or warrants of gold and silver mining/royalty companies rather than in the bullion itself.

Last Week’s % Performance(1)

All calculations are based on U.S. dollar equivalents
(2) Week ending October 23rd, 2009

(3)HUI is the symbol of the AMEX Gold BUGS Index consisting of a Basket of Unhedged Gold Stocks.
It is a modified equal dollar-weighted index of 15 large/mid cap gold mining companies that do not hedge their gold beyond 1.5 years.

(4)GDM is the symbol for the NYSE Arca Gold Miners Index.
It is a modified market capitalization weighted index of 31 large/mid/small cap gold and silver mining companies.

(5)CDNX is the symbol for the S&P/TSX Venture Composite Index.
It consists of 558 micro- and nano- cap companies of which 44% are engaged in the mining, exploration and/or development of gold and/or silver and other mineral resources and 18% in oil or natural gas pursuits.

(6)CCI represents the Commodity Companies Index.
It is an equal dollar-weighted index consisting of 36 commodity-related companies with warrants of at least 24 months duration outstanding trading on the Canadian and U.S. stock exchanges.

(7)CWI represents the Commodity Warrants Index.
It is an equal dollar- weighted index consisting of 47 warrants of at least 24 months duration associated with the 36 companies in the CCI.

(8)GSCI represents the Gold and Silver Companies Index.
It is an equal dollar-weighted index comprised of the 22 gold and silver mining and royalty companies with warrants in the CCI.

(9)PMWI represents the Precious Metals Warrants Index.
It is an equal dollar-weighted index comprised of the 26 gold and silver warrants, of at least 24 months duration, found in the CWI.

Sources: preciousmetalswarrants.com (warrant and stocks-with-warrants data), oanda.com (exchange rates) and stockcharts.com (index and commodity prices).

Why Own Precious Metals Mining/Royalty Stocks instead of the Bullion Itself? Leverage

If gold, for example, were to escalate considerably in price (i.e. to $2,000, $3,000, or even more) in the next few years it would have a significantly positive impact on the profitability of the companies who mine it and the royalty companies that buy it from marginal producers. For example, with gold priced at $1,000/oz., and the cost of production at perhaps $600/oz. the gross profit margin of gold mining companies would be 40.0%. If 2 years from now, however, gold were to increase to $2,000 and the cost of production were to increase by only 20% to $720/oz. then the mining companies’ gross profit margins would have gone up from $400/oz. to $1280/oz. or 220%!

That’s called leverage and historically, in a rising market, the ratio for gold and silver mining and royalty shares vs. physical gold ranges from about:

1. 2.5:1 on average for large-cap gold and silver mining and royalty companies to as much as
2. 5:1 on average for smaller cap gold and silver mining and royalty companies and even
3. 10:1 in exceptional circumstances for certain truly outstanding performers.

All the more reason to do your due diligence to find and invest in those gold and silver mining and/or royalty companies with the right mix of capable management, strong financing, major resources and geographically and politically well-located properties to reap the major benefits a surge in the future price of gold and silver will present.

What is the Benefit of Owning the Warrants of certain Precious Metals Mining/Royalty Companies? Leverage-on-Leverage

For those who buy the right long-term warrants associated with the right gold and silver mining and/or royalty companies at today’s still undervalued prices, your eventual returns would likely be 1.5 to perhaps as much as 3 times greater (currently 1.5:1 YTD for the Precious Metals Warrants Index vs. the Gold and Silver Companies Index) on average than had you invested in their associated stocks.

 For companies whose warrant prices go through the roof with extraordinary gains, in and of themselves, or from extremely depressed values, as experienced in 2008, that ratio could be 10 times greater than having invested in the metal itself (currently up 9:1 from its 52-week low).

Such over-and-above gains are referred to as leverage-on-leverage or doubling-up on the leverage factor. The catch is, however, that you have to know whether or not the warrant associated with the stock you are interested in buying is the right warrant i.e. has a high enough leverage/time value to justify its purchase given the anticipated appreciation in the price of the associated stock. For those who don’t know what a warrant is, which companies have them, which have the best values and exactly how to go about buying them check out the Precious Metals Warrants site hyper-linked below.

Conclusion – Let’s do the Math

1. If gold were to increase from its current range of $1030 - $1060 to $5,800 as projected by the Aden sisters that would represent an increase of approx. 455%. The current leverage exhibited by the component stocks of the HUI is 2.2:1 vis-à-vis gold. Were that leverage applied to future gold and silver mining/royalty company equity prices it would extrapolate into an average price increase of approximately 1000% (455x2.2) for such large-cap stocks.
2. Applying the current YTD performance of the GSCI, which is out-performing gold bullion by a 3.3:1 margin, one could anticipate an average increase of 1,500% (455x3.3) in the average stock price of gold and silver mining/royalty companies with warrants.
3. The component warrants in the PMWI have out-performed the price of gold by a margin of 4.8:1 YTD which would suggest that the average warrant could expect to increase by approximately 2,184% (455x4.8) were gold to escalate to $5800! And that is on average.
4. Indeed, if the trend to date of the GSCI to gold ratio from its average 52-week low (i.e. 4.4:1) was to continue the projected 455% increase in gold would extrapolate into a 2000% (455x4.4) increase in the price of the average precious metals mining/royalty stock and an amazing 4,140% (455x9.1) in the price of the average warrant!
5. Now if the right gold company stock was to increase 10 times that of the price of gold then it would increase by about 4550% (455x10). If you were fortunate enough to have selected the right warrant of the right mining/royalty company that was outperforming the performance of the associated stock by a 2 to 1 margin (the current ratio is 1.45 to 1) you would be reaping a return of 9100%. That seems highly speculative but if the history of how certain stocks performed in the 1976 to 1980 period is any indication such major returns are, indeed, possible.

So, in conclusion, “What Would $5,800 Gold Mean for Junior miners?” It would mean much higher prices for their stocks and associated warrants – much, much higher!

Lorimer Wilson

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Lorimer Wilson is an economic/financial analyst and commentator writing on the major economic and financial crises of our times plus articles on precious and rare earth metals, investing in times of crisis, analyses of gold mining indices and gold. He is a Contributing Editor to www.preciousmetalswarrants.com and contributor to a large number of other sites.