Is it time to buy gold miners?

With gold miners held in such low esteem by investors, now could be your chance to buy into this unloved sector, says Bengt Saelensminde. Here, he tips one exchange-traded fund to buy now.

Everything seems to have gone a bit quiet on the gold side of things. But we haven't forgotten old yella. There was, as you might expect, a fair bit of talk about gold's destination atthe MoneyWeek conference.

Tim Price was there. Tim manages the private accounts of some fantastically wealthy investors. Now at last year's conference I was amazed when he let it slip that he had nearly half of his own wealth invested in gold. Well, this year we found out that he's upped the ante...

Shock, horror: he's now got nearer 80% in precious metals and miners. But doesn't this weighty chunk in a single asset-type concern him? "No. It's the other 20% that worries me!" I'll tell you why on Friday.

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Now, I'm not suggesting you should have anything like 80% of your assets in precious metals (or anywhere else for that matter). But a 10% allocation could provide some useful insurance against financial calamity.

And investing in gold miners not only brings a bit of diversification, but it's a way of getting some income from your investment too.

Better still, today the gold miners look extremely cheap. Investor sentiment is on the floor. Now is a great time to take a look at this bombed out sector

Gold miners are really hurting

Here's an interesting chart. It shows two ETFs (exchange-traded funds): Market Vectors gold miners and the SPDR gold bullion ETF.

GDX versus GLD

12-05-23-TRS-1

(Source: Yahoo! Finance)

I like ETFs basically they're funds that aim to track a particular index. That could be the FTSE 100, the Dow most major indices are available. In this case, I'm showing you two American ETFs, one for the large gold mining stocks, and another for gold bullion.

You can buy ETFs through your regular stock broker, though in this case, you'll need to be able to deal US stocks.

Now, as you can see from the chart, before the great panic of 2008, the two lines progressed in relative harmony. The gold price goes up (blue line), the gold miners make more profit so the gold mining index goes up (red line).

But what with stocks being stocks (and gold being gold), the miners took a severe pasting during the crisis. And though stock markets have since recovered, the gold miners haven't received the same attention.

During the six years since it was launched (see graph), the miners ETF is up around 10%. Yet the gold bullion ETF has increased by over 130%.

And recently things have been even worse...

Back in October I made the argument that gold miners were cheap. The GDX index was back where it was in late 2007 when the gold price was around $700.

Of course today, gold is trading around $1,550. Many mining outfits are pulling in serious profits yet, the stocks are in the doldrums.

And things have gotten worse since then. Since I recommended GDX in October, it's fallen from $59.5 to $42.56 that's nearly 30%. Meanwhile gold has fallen around 10%!

I did say at the time that the mining index could continue to underperform. But I've got to say, I'm surprised to see the continued pessimism in the stocks.

A golden opportunity?

One reason why sentiment is so poor is probably down to something we touched on a couple of weeks ago. And that is, anything that's in the ground can be taxed, or even expropriated by governments. We saw how in Argentina and Bolivia, the governments had taken' back (nicked!) Spanish assets.

A government in trouble is a dangerous beast. And many mining companies operate in exotic locations. You cannot simply pick up a mine and put it somewhere less risky.

Gold bullion, on the other hand, is a mobile store of wealth. That's precisely why so many people like it. Even the central banks have turned from sellers to buyers. They want bullion not mining stocks.

But that leaves an opportunity. If you're prepared to take on a bit of risk, then there could be some serious profits in the mining stocks. Remember, there are dividends on offer, and if the gold price goes up, profits usually ramp up even quicker. If you want an explanation as to why, see my piece from October.

I like the Market Vectors ETF (NYSE:GDX). It's a $9bn fund giving holders exposure to the world's 31 largest miners. Something that could be useful given the inherent political risks holders face.

But bear in mind, this is a risky play on gold. As history demonstrates quite clearly, a gold miner may not follow the price of bullion upwards yet in a downturn, they can get hit just as hard. And this ETF is only available in the States that means there's currency risk (or diversification benefits depending on how you look at it).

On a personal note, I'm hoping the miners have already had their fall and if anything, the price is already discounting a fall in gold. So if gold goes up, then there could be a catch-up bonus on the part of the miners.

Buying when sentiment is on the floor is usually the best time to hop aboard. I'll keep you updated on this opportunity as it develops.

This article is taken from the free investment email The Right side. Sign up to The Right Side here.

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Bengt graduated from Reading University in 1994 and followed up with a master's degree in business economics.

 

He started stock market investing at the age of 13, and this eventually led to a job in the City of London in 1995. He started on a bond desk at Cantor Fitzgerald and ended up running a desk at stockbroker's Cazenove.

 

Bengt left the City in 2000 to start up his own import and beauty products business which he still runs today.