Could Chinese New Years Fuel the Next Rally Higher for Gold & Gold Stocks?

February 4, 2008

Last week, I wrote an article called “Even After a Strong Run, Gold Stocks Still a Bargain.” In that article, I wrote that gold stocks, both the majors and especially the junior resource stocks, were highly undervalued given historical ratios of gold stocks to the price of their underlying commodity. In fact, as of last week, I wrote that many majors were trading at the same share prices they were at when gold was only $830 an ounce. So I concluded that either the price of gold was going to have to come way down or the shares were going to have to go way up. I concluded that the shares would have to go way up, and I’m still concluding that, but with a slight modification.

Technically, gold futures contracts are showing a bearish rising wedge pattern so there is the imminent risk of a minor correction now. I say minor and not major, because I just can’t see gold retreating all the way back to $800 an ounce. I just think that such a significant retreat, given the vast problems in the global economy, and particularly in the U.S., has a very small probability. My downside projections for a correction are somewhere within the $850-$860 range if we see a correction, but should gold retreat to this range, I believe that this retreat will be very short lived as savvy investors will definitely view such a correction as a buying opportunity and jump into the market at this point to drive the price of gold higher again. As far as the “gold is too high” believers, even if gold doesn’t retreat by $40 or $50 an ounce, I believe that even at $900 an ounce, long term buyers of gold and those that have already been buying for years will be just fine adding to their current gold bullion positions at this price. At every step of the way during this current gold bull run, gold has been “too expensive”. It’s been “too expensive” at $400 an ounce, at $500 an ounce, at $600 an ounce, at $700 an ounce, at $800 an ounce, and now at $900 an ounce. The fact is that this gold bull run has a long long way to run.

As far as why I believe any such correction, if it happens, will be very short-lived, China provides some of the answers. A gold futures market just opened up in Shanghai on January 9th, with apparently plans for a silver futures market on the way as well. The Shanghai futures market may not have a lot of impact for now in the global market for gold, but it is an important global development as it definitely raises visibility of gold as an investment vehicle in China. With A-shares (shares of Chinese stocks available only in the Chinese mainland) still trading at ridiculous valuations and at 80% premiums to their H-shares counterparts (the shares of the exact same Chinese stocks that trade in Hong Kong), Chinese investors that are now sitting on 300% to 400% profits on their stock portfolios in just several years will be well served to take their profits and seek a new home for much of that capital. Gold may just be the winner in this rebalancing equation.

With (1) China overtaking South Africa as the world’s largest gold producer last year (a situation unlikely to change this year with the three largest mines in the world hampered by South Africa’s nationwide electricity emergency) according to London precious metals consultancy GFS limited; (2) Chinese New Years on our doorstep; and (3) Gold having thousands of years of significance as a traditional sign of prosperity and fortune in Chinese culture, I believe that China would serve an important role in propelling this current gold bull run to much higher heights. The fact that A-shares are still trading at an 80% premium to H-shares is proof that the local Chinese market is somewhat insulated from movements in the rest of the global economy. I believe the same will hold true in the gold market. Chinese believe in gold and what the rest of the world thinks won’t matter to their buying behavior. I would surmise that even if those living in China read my belief that gold could see a temporary dip lower in prices that this would not stop them from buying at $900 an ounce. So how will this affect the global spot market for gold? In the short-term, probably hardly at all. However in the long-term, the bullish behavior of the Chinese gold market will force the world to stand up and take notice and will eventually be priced into markets in London, Zurich and New York.

So here’s my call. Gold, if it does correct in price, may also temporarily drag the prices of gold majors down with it (juniors, due to their significant lag, should not be affected much during this correction if it happens). However, if a correction happens, both in the price of gold and gold stocks, they will be very short lived, and the price of gold, as it recovers, will finally propel gold stocks to their much higher level, as each subsequent dip and recovery in the price of gold encourages more and more of the fringe investment community that this gold bull run is for real, and thus, encourages more and more people to hop on board. In any scenario, whether we see a small retreat in the price of gold, a larger retreat in the price of gold, or no retreat at all, gold stocks, at some point in the near future (and especially the juniors) will handsomely reward our patience even more than the price of the underlying commodity has already rewarded us. Learn more about how to invest in gold and gold stocks here.

[tags]gold, gold stocks, China, Chinese New Years[/tags]

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