Junior Gold Stocks Could Be Bottoming But Investors Must Be Extremely Selective

Gold stocks have been underperforming for close to two years now, which is a very long time compared to the previous runs. In an interview with The Gold Report, author of the book “The Great Super Cycle” and newsletter writer David Skarica points to a Maximum Pessimism Trade.

The key point that David Skarica makes about the gold stocks is the following:

Unfortunately for gold investors, historic valuations of gold stocks linked to the price of gold have remained undervalued for too long. If you look at valuation metrics of large-cap gold stocks compared to the price of gold, many of these stocks are historically at very cheap valuations and that has persisted for some time. The AMEX Gold BUGS (Basket of Unhedged Gold Stocks) Index (HUI), is trading at roughly $420–430. It broke $400 to the upside for the first time back in 2006 when gold was in the $600–700 range. That tells us where we are. In the past year, gold stocks have been undervalued by anywhere from 20–50% based on historical valuation methods. Despite the bargain prices, a rally has failed to materialize.

Junior gold miners have significantly underperformed since early 2011, as visible on the next chart that represents the CDNX index.


The underperformance was also a surprise to the author. He confesses that investors need to be extremely selective in this market. We wrote earlier that Rick Rule, considered as one of the most knowledged and successful resource investors, believes that the junior resource market will go (much) lower in 2013. He expects that 80% of the 4.000 junior exploration companies are non-viable.

The junior miners will attempt to reach their intrinsic value, which is zero. We are going back to 1991, a period in time that was characterized by frequent delisting of junior companies. That movement will likely start in the first quarter of 2013. The best 5 to 15% of the juniors and explorers have probably already bottomed although the bottoming process may take an additional period of 6 to 12 months. Occasionally, however, we will witness pretty dramatic escalations.

For investors on the outlook of guidance in their due diligence, Casey Research created a framework for investors, The Eight “P’s” of Resource Stock Evaluation, which describes how to increase the success in picking the right mining companies to invest in. This framework is based on the analysis of eight criteria which aid in evaluating natural resource companies and measuring their quality as an investment.

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