Cash From Chaos as Gold Shines

While geopolitical turmoil has sent the broader market lower recently, gold stocks have been on a tear, and analysts say the gains could well continue this year.

Like most commodity prices, gold has risen over the past 12 months amid a weakening dollar, low interest rates and strong investor demand.

Although gold has been in a correction for most of 2004 following a big surge at the end of last year, geopolitical events recently sent bullion higher, and gold stocks have jumped 4% since March 15. Meanwhile, the S&P 500 has fallen more than 1%.

The perception that world violence is escalating bodes well for gold because in times of political or economic uncertainty, investors often flock to assets that they consider safe havens. But even if the geopolitical landscape improves or falls off investors' radar screens, pundits say there are many reasons to be bullish on the group.

Merrill Lynch analyst Michael Jalonen believes gold prices will rise in April though mid-May because he expects consumer demand will be strong in India as the wedding season approaches.

He said gold jumped from $345 an ounce in early April to $375 in mid-May. Following the same pattern, he says gold could rise to $425 by mid-May.

Gold futures were recently sitting at $417 an ounce. Other analysts are more cautious on the very near term, however.

David Skarica, editor of the newsletter Addicted to Profits and vice president of research at Freemarketnews.com, said while the dynamics of supply and demand are important, gold prices tend to trade on emotion. He noted that whenever bullion moved in a range of $420/oz to $430/oz over the past 10 years, rallies have often failed.

"Over the next six to nine months I'm pretty bullish, but over the very short term it's going to be tough to take out those levels," he said, adding that he expects gold to reach $460 an ounce by year-end.

Geoff Stanley, an analyst at BMO Nesbitt Burns, agrees there's no urgency for investors to step in right now, although "there's a strong case" for higher gold prices over the long term.

"You've still got a low interest rate environment," he said. "You have major producing companies reducing their hedges quite aggressively. You have a trend towards instability and weakness in the dollar. You've got the problem of the twin deficits in the U.S., so there's a lot pointing towards firmness in gold prices in the medium to long term."

As with most commodities, gold is priced in dollars. So, gold prices rise when the greenback is falling, as has been the major trend for the past three years. And with interest rates expected to stay low for much of this year, many analysts say the dollar should continue to slide. (Still, recent strength in the dollar, especially vs. the euro, is one reason near-term caution on gold is warranted.)

Stanley expects gold to move "markedly higher" over the next six to 24 months, and because gold stocks typically lead the price of bullion, this is clearly a positive trend for the sector.

While the group isn't trading at bargain prices right now, analysts say many stocks still look reasonable. Merrill's Jalonen said North American producers trade at an average price-to-net-asset-value multiple of 2.2, which is close to the historical median of 2. "We believe gold equities have further upside potential," he said.

Patrick Chidley, an analyst at Barnard Jacobs Mellet, believes the stocks could rise 20% to 40% over the next year, as gold prices continue to move higher. "Hardly any of the stocks are cheap but the outlook is for improving earnings," he said.

Chidley said his favorite stock right now is Placer Dome ( PDG), which he feels is attractively valued.

Skarica, meanwhile, prefers riskier names like Eldorado ( EGO), Cambior ( CBJ), Richmont Mines ( RIC) and Golden Star Resources ( GSS).

"The reason I like them is they all have current production, so they have a source of revenues and will trade with the gold price. But they also have exploration upside," he said.

Eldorado, which Skarica owns, has only one producing asset -- the Santa Bento mine in Brazil, which produced 95,049 ounces of gold last year. If anything were to happen to the mine and production were to be shut down, the stock would no doubt be crushed. But Skarica likes the firm because it plans to develop a mine in Turkey with proven reserves of 5.3 million ounces. "Stocks like Eldorado are pricing in future production," he said.

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