Why gold is still a good long-term play

The gold price has pulled back but we're not seeing a reversal in its fortunes, writes Casey Research's David Galland

So... do we at Casey Research think we're now seeing a reversal in gold's fortunes? In a word, no.

I'm not going to go into meticulous detail here, but I do want to share some thoughts with you that may be of some use... if for nothing more than playing them back to me in sarcastic emails several months down the road if we're proven wrong.

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A few key things to ponder as the battle for $900 gold rages...

1. The current correction is not yet exceptional: Since the current bull market began in earnest in 2001, there have been nine corrections in excess of 8%.

During the three worst pullbacks, gold fell 15.98%, 18.27%, and 27.7%, respectively. And the average of those corrections is 13.6%, so the latest, which touched 18% at its worst, is only marginally worse than average.

Put another way, for the current pullback to match the sharpest correction to date, a drop of 27.7%, gold would have to fall to about $730. Could it happen, again? Sure, why not?

And if it does, rest assured that, just as they did when gold moved down by that percentage in May of 2006 - falling from $725 to $567 - analysts will line up to say that the back of the gold bull has been broken. But if you had listened to the naysayers back then and bailed out at the bottom of that correction, you would have missed a rebound of close to 100%.

I mention this to stress that the fits and starts we are currently experiencing are nothing unusual. Quite the opposite, they're the norm for any sustained bull market. In the 1970s' sustained gold bull market, a similar pattern occurred.

The bottom line is that if you are going to invest in the resource sector, you need to take a long view. And, I would stress once again, you have to be invested with money that you can afford to lose a substantial portion of and not be overly concerned. Otherwise you'll invariably become shell-shocked during periods of volatility and be prone to breaking ranks and selling at the worst possible time.

2. The big gold companies are delivering: One of the largest mining companies in the world, Newmont Mining (NYSE:NEM), just released its first-quarter 2008 financials, the first of the big gold producers to do so.

As we have been forecasting, they had record sales of $1.94 billion, realised a record price of $933 per ounce sold, and saw their cash operating margin soar by 119% from the same period last year. Further, net income was up 444% from Q1 last year. And the company's cash operating margin rose to a record $537 million in Q108 over the prior record $419 million earned in the previous quarter.

Over the next couple of weeks, we'll see a string of similar results from the other major producers, offering a stark contrast to the billions upon billions in losses being suffered by the banks, investment houses, housing industry, airlines, etc.

So, what happened to Newmont's shares on releasing its financials? They fell, albeit modestly, victim to this week's softening gold price and a dumb remark by the minister of mines of Ghana - where Newmont has significant projects - about the need for mining reform in that country. More on that latter topic momentarily.

The key point is that the increase in the profitability of the gold miners, a prerequisite for the entire gold share complex to get moving, is now materialising.

3. Oil is stubbornly holding on over $100 and food prices are on the rise everywhere. This is simply the most visible evidence of the inflation now gripping the world.

We've said for years that there is a very tight correlation between rising oil prices and rising gold prices. While oil prices may moderate at some point - because, again, no market goes straight up or down - the trend is clearly for sustained high prices. This is additional support for gold in our view.

So... given gold's correction, you might go right ahead and sell your gold. I'm hanging on to mine. And if I'm hanging on to my gold, I'm hanging on to my gold stocks, because that's where the real juice will be.

When I look at the alternatives and the amount of risk I have to take to get even a 10% return right now, I am comfortable biding my time, continuing to buy gold and gold share bargains with the expectation that the 100%, 200%, 500% gains down the road will catch me up in a hurry.

by David Galland for The Daily Reckoning