Commodity Q&A: Gold Could Erupt at Any Moment

Q: Matt, my gold stocks haven't done anything in months... what's going on? – G.G.

 

A: Gold miners are flat because the price of gold is flat. But I think it'll pay for you to be patient. Let me show you why...

 

After years of declining prices in the late 1990s and early 2000s, gold climbed from about $250 an ounce to more than $425 in late 2004.

 

Gold needed time to digest those easy gains... and moved sideways for 17 months before breaking out and seeing an extraordinary run higher to $710 by May 2006. Again, gold needed time to digest. That big run was followed by a 16-month sideways period.

 

Then, in September 2007, gold broke out again. This led to another huge run higher... from $700 to $1,000. And just like the breakout that preceded it, this breakout has been followed by a digestion period.

 

The yellow metal has been bobbing between $700 and $1,000 an ounce for the past 18 months. Three times gold has "bumped its head" on $1,000 an ounce... It was turned back each time.

 

 

 

But in the last four months, gold has quietly worked its way to a series of "higher highs" and "higher lows." It now trades for around $950 an ounce. I believe we're due for another assault higher in the next few months. And I believe the fourth time will be the charm. This will be the official breakout to more than $1,000.

 

Now, G.G., you're perfectly positioned. You see, one of my favorite ways to take advantage of a gold breakout is through gold mining companies.

 

Gold miners are "leveraged" to the gold price. They produce gold at relatively fixed costs... so when gold jumps a bit, their profits can jump A LOT. Let me explain...

 

Let's say a gold miner spends $400 per ounce of gold to get it out of the ground. So when the price of gold is $500 per ounce, it makes $100 per ounce in profit. If our company produces 100,000 ounces per year, it earns $10 million.

 

Now, let's imagine gold goes to $600 per ounce. Our company will make $200 per ounce, or $20 million in profit. Gold is up 20%, but our company's profit has doubled... and its share price will follow.

 

While it's not usually that pronounced, you can see the exaggerated gains by comparing the breakouts of the gold price with the performance of the major miners.

 

For example, from May 13, 2005 to May 12, 2006, the price of gold rose 71%. Over that same period, the AMEX Gold Bugs Index (which tracks the major gold mining stocks) went up 105%. Gold made its next run, a 51% gain, from August 2007 through March 2008. That prompted the Gold Bug Index to soar 62%.

 

If gold can break out past $1,000 and continue higher, the major gold miners will see even bigger gains. So don't fret about the performance of your gold miners. Their time is coming.

 

Good investing,

 

Matt Badiali

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