How to Lose Money in Gold as Gold Rises
By Matt Badiali
September 14, 2007

"I just sold all my shares of Goldcorp," the speaker leaned conspiratorially in toward me.

"They've really disappointed me. Their shareholders are taking a beating and I am sick of it. I can find better value elsewhere."

The speaker was the CEO of a public company with decades of mining experience. We were sitting in the back of the room at the Long Beach Gold Conference. I was surprised, to say the least. The price of gold is up nearly 60% in the past two years. So why on earth is he dumping shares of the companies that sell the stuff?

You see, unlike Big Oil, whose profits are breaking records as the price of oil rises, gold producers can't seem to get on track. Shares of Newmont Mining (NEM), one of the most widely held gold stocks on the market, have moved essentially sideways for the past three years. Goldcorp (GG), with an $11 billion market cap, has done the same since the beginning of 2006.

There are some big headwinds blowing against gold producers. First, costs have climbed dramatically over the last few years. It takes a lot of raw materials to build and run mines. Over the last four years, the price of diesel fuel is up 163%, rubber for tires is up 57%, and copper wire is up nearly 300%. Labor costs are also rising as the industry fights for skilled workers.

Meanwhile, the price of gold has increased by "only" 87% over the last four years.

Clearly, earnings are being crimped. Agnico-Eagle's (AEM) earnings fell four of the last nine quarters, including two of the last three. The estimate for this quarter, which ends in October, is lower than last quarter. Newmont and Goldcorp earnings have fallen five of the last nine quarters.

Also, a wave of expensive acquisitions has hurt shareholders. Many large-cap miners are desperate to acquire more resources, and the stock market is one of the first places they dig.

The acquisition that could be the boondoggle of the decade is Agnico-Eagle's purchase of Cumberland Resources for a whopping $177 per resource ounce, for a total cost of $580 million. While that was a great deal for S&A Gold Report subscribers (we made 93% on our Cumberland shares), Agnico-Eagle shareholders were not so happy. Agnico-Eagle stock declined 17% the day the company announced the offer.

Although Cumberland's Meadowbank deposit is nearing construction, the site is so remote that supplies must come in by ice road. Prior to the buyout, many experts were skeptical that the project would even become a mine.

Agnico-Eagle shocked most of the mining community. High gold prices, if they last for a few years, could make Agnico-Eagle's deal look smart. However, if gold sags back around $400 per ounce, the mine could shut before it ever goes into production.

Don't get me wrong... a gold price of $800 or $900 will cure nearly all ailing mining stocks. If you want to participate in that rally, a basket of these stocks, rather than individual companies is a good way for the passive investor to get exposure. An ETF like the Market Vectors Gold Miners ETF (GDX) mirrors the return of the AMEX Gold Miners Index.

But my recommendation to the nimble gold speculator holds much, much more profit potential. Use the big miners' weakness against them. Their need for new resources will provide a gigantic boost to small companies that A) own attractive deposits... or B) get paid to prospect for new ones.

Of course, this approach requires more homework and a close eye on your portfolio... but in an environment of rising gold prices, this is where you find triple-digit winners. I think the extra homework is more than worth it.

Good investing,

Matt Badial