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October 15, 2009

Gold and Gold Stocks to Benefit
by Neil Charnock

Introduction

Gold and gold stocks are going to continue to benefit from the current economic and political climate. This opinion is based on what I consider to be the true state of the global economy and other prevailing head winds. Martin Hutchinson penned a great article "When Money Becomes Worthless" promoted on GATA this morning (I got it via Chris Mullen's Gold-Seeker email update service) and posted at the PrudentBear.com.

I want to encourage readers to find and read the piece because I believe it makes good sense and also points the way to another potentially powerful force for gold stocks.

This excellent piece discusses some potential outcomes stemming from the excess stimulus capital which has been flooded into the financial system. It is well worth your time and attention. It discusses historic and current money flows in relation to physical commodity supply conditions - which include physical demand for gold and silver. It discusses possible disruption to supplies of physical commodities, the lack of fiscal tightening which is needed to soak up excess liquidity (money supply) in the financial system and the diminishing time remaining to rectify related problems - a must read in my opinion.

Monetary tightening is not considered possible in the US and other teetering economies - "the stimulus must remain". This is even the stated policy in Australia where they have just raised interest rates!

I would also agree that if Martins logic is correct, and all signs point to this being a true statement at this stage, we will see further controls inflicted on the gold market. I am not sure that governments will attempt control by selling off remaining gold hoards however - they see the physical gold as too important / too valuable themselves. However I like Martin's point about commodity purchases being driven "underground" so to speak in the event of excessive controls - the people and the money will find another way to invest in commodities (including gold and silver) if restrictions are put in place. This is just human nature.

Gold Stocks - The Opportunity

Given the global nature of the gold markets and the level of interest now building I consider that if all this comes to pass, restrictions on physical gold / silver supply or bullion ownership - or restrictions on futures contracts - will only serve to drive some of that demand into gold stocks instead.

Gold stocks have been described as un-dated gold options and for good reason. Indeed they do not expire and they do, at times, present opportunity for leverage. Sure you have to pay full price but the thing is that they can significantly amplify a gold price rise because their profitability can rise at three (or more) times the rise in the gold price.

This means you gain greater profits and have the luxury of getting your timing a little wrong without getting hit with margin calls or expiration "out of the money" (investment becomes worthless). Provided the company is not in trouble (diving share price) you can usually afford to wait until you are right at least for a reasonable period of time.

Remember you cannot ignore the technicals if you want to learn to time gold stock investments. This is essential if you want to really do well from your investing activities. A great mining stock story can take years to evolve and eventuate in a strong price movement whereas learned technical set-ups once identified can usually be executed and profited from over a much shorter time span.

At times the gold stocks get priced ahead of gold and other times gold leads the way leaving gold stocks undervalued compared to gold. Beware when this latter event evolves after a long strong run because it can mean the smart money is liquidating - selling out. The gold stocks flatten off under these circumstances but gold shoots upwards in the final throws of a parabolic spike.

Gold just broke out and must test the break out level as yet - this is not the end of this rally in my opinion. I am aware and watching this carefully even still in case I am wrong - only the market is right.

Because we have already seen excellent gains in several gold stocks over the past few months you have to choose carefully to gain the greatest leverage for your capital but I would state with certainty that some of these stocks are severely undervalued at this time.

GoldOz presented an educational piece in late August showing one method of valuing a gold stock. Yesterday the main stock in the study topped (temporarily) at a clear gain of 140% showing exactly what I have been talking about. The timing could not have been better in that case and a number of other stocks were compared to that one at that time.

The gold stock price action has been mixed and this is typical of the early and middle stages of a gold rally. Many of the gold stocks on the ASX have only just completed their base now and made their initial move up from the floor. Lots of room for upside - this is exciting and I expect things will stay this way at least until February and perhaps until May next year. That is 4.5 to 7 months of trading bliss ahead of us if this theory is correct.

I have been creating special files for my Gold Members subscription area that simply presents information for investors. They can then deduct which companies are good value by using simple valuation and performance metrics like the one I used to locate and describe the example that just ran to 2.4x its base price at time of writing. The files also contain a few fundamental snippets of data direct from company reports which can indicate what is holding them back or propelling them upwards.

Recently we added a table to show the current market leaders in terms of internal strength and that presented some fantastic opportunity as some have already blasted off.

A nice breather today in the XGD (Wednesday 15th) as it cooled off a few of the hot runners and I hope they take a few days rest now so the price can come back once again to outstanding value.

The aggressive and experienced investment capital moves between stocks because once they have finished their run it becomes time to work that capital via fresh investment. This selling and movement often causes these small pull backs.

They say all boats rise on a rising tide but I have found that they move at different times and this fact can be exploited.

Gold Update

Gold has held above US$1,030 for 7 days now which is a good sign and I expect this price action to follow through higher due to fundamental forces. There is no technical reason to disagree either as I see no sign of negative divergence. The fact that gold can do this when it is no friend of the powerful dominant banking institutions is quite a feat.

This factor is often overlooked - most of the profit centres of these banks make less money in a strong gold environment. Apart from the commodity desks, gold is not good business for these institutions which control massive capital reserves and direct massive money flows.

It is not in their interest for gold to be strong because this inherently indicates instability, inflation or lack of confidence which their other departments rely on for profitable trading. It is simply bad for business - with the exception of gold stocks.

Therefore gold price strength has to overcome these significant negative forces amongst several others highlighted by some of my colleagues. It is important for new investors coming onto the scene to understand this because it enforces the power and longevity inherent in this long term gold bull over the past 8 years. Imagine what the price would have been if it did not have to swim against the tide.

Gold is not trading at record highs in many other currencies as yet however and I do look forward to the day when we reach that point. This means the best is yet to come.

The disequilibrium of sovereign recovery rates after the instability that finally surfaced in the financial system late last year is causing this disparity in gold: currency valuations. Australia has fared very well so far due to a number of reasons and our Reserve Bank has just seen fit to raise interest rates following Israel. This is why the AUD gold price is well below record levels - but still in highly profitable territory for the mid to lower cost producers.

This is not a coordinated recovery on a global scale by any means and the variation between interest rates across sovereign boundaries is causing hot money to flow in currency carry trades and this is also serving to push currencies around as banks fight to rebuild their balance sheets.

Gold is doing great against nearly all currencies short term but there will come a time when it outperforms all currencies with great strength as the gold bull gathers a greater head of steam. There is already sufficient interest and excitement about gold and the gold stocks around the global markets to drive a rally into the coming months so I believe we will see this sooner rather than later.

The global banking system is still in some trouble - this is clear from everything I am reading. I admit I stay away from most mainstream reporting and this is why most of what I am reading points to trouble ahead and not "fairyland back to normal" spin.

Europe and the UK, Japan and the US of course are all still in financial hot water. Spain for instance looks solvent despite near 20% unemployment which is apparently carried by recently imported workers that worked in the recent unprecedented building boom.

When you dig deeper however and allow for the pre-requisite optimism by their leading banks there may be deeper currently hidden problems which are also indicative of the wider global banking climate. The global banking spin machine is running as fast as the printing presses - it is hiding the true state of affairs trying to buy time so it can regain solvency and build back vital reserves and a buffer to offset the losses not yet realized.

Spanish resident Economics Professor Ed Hugh and the financial research house Variant Perception argue that Spanish regulators and banks are conspiring to hide Spain's insolvency.

Spain must not be allowed to go the way of Iceland and Latvia because the bailout and fallout in the EU would spell d.i.s.a.s.t.e.r. in terms of cost and disruption. This spells danger in the EU particularly if Greece and Italy are also factored. But this is likely (I hope) to remain an undercurrent just like in the UK.

The undercurrent will morph into an obvious problem if things get out of hand and I for one believe that tier one capital injections will be required for the global banking system to remain solvent in the coming months / years. This is going to be a long slow painful bear similar in nature to what we have seen in Japan over two decades.

I have just added Euro gold and silver charts to my home page at GoldOz because of the growing irrelevance of the USD prices of commodities. I get asked quite often - when will this international pricing in USD's change? It must change because the instability in the USD is causing problems for producers but I cannot say when - anytime is possible and moves are already afoot.

We are still running a special offering some free bonus time for Gold Member subscribers and I hope you will join us - or at least join in the fun and make some money in the coming months.

Good trading / investing.

Regards,

Neil Charnock
www.goldoz.com.au

GoldOz has developed a Member area and has added further resources for free access. We have stepped up our research and stand by to assist investors from all walks of life. GoldOz web site is a growing dynamic resource for investors interested in PGE, silver and gold companies listed in Australia, ASX share quotes, Aussie Gold Index charts, brokers, bullion dealers and company research via our paid Membership services.

Neil Charnock is not a registered investment advisor. He is a private investor who, in addition to his essay publication offerings, has now assembled a highly experienced panel to assist in the presentation of various research information services. The opinions and statements made in the above publication are the result of extensive research and are believed to be accurate and from reliable sources. The contents are his current opinion only, further more conditions may cause these opinions to change without notice. The insights herein published are made solely for international and educational purposes. The contents in this publication are not to be construed as solicitation or recommendation to be used for formulation of investment decisions in any type of market whatsoever. WARNING share market investment or speculation is a high risk activity. Investors enter such activity at their own risk and must conduct their own due diligence to research and verify all aspects of any investment decision, if necessary seeking competent professional assistance.

Copyright © 2009-2010 Neil Charnock

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