This slump could be a good opportunity to buy gold stocks

Even as the price of gold hits new highs, gold mining stocks remain in the doldrums as fear stalks the equity markets. But once the markets settle down, gold stocks may become too good to ignore, says Dominic Frisby.

Suddenly everything matters again.

Just a few months ago, it seemed that no amount of bad news could get in the way of the inexorable rise of the stock market. Now it's the opposite.

America finally resolves its debt ceiling farce. Many might have thought that would mark a low and markets would turn back up. No such luck. Yesterday, all of a sudden, the issues in southern Europe mattered to the US, along with fears over falling US consumer spending.

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As the Spanish prime minister cut short his summer holiday to deal with his country's economic crisis, the Dow Jones index fell over 250 points by the close in New York yesterday. That's eight down days in a row, the longest losing streak since the crash of October 2008.

Fear and panic are back at the helm.

Fear is driving the markets now

Fear and greed. These are supposed to be the two main emotions that drive markets.

There has been a flight to the US government bond market and yields look silly once again. Gold has broken out to new highs. Yesterday it touched $1,660 an ounce, having begun July around $1,480. But there's been nothing greedy about these latest rallies in the precious metal. It's been pure fear.

The rise was not mirrored by gold stocks, which both senior and junior ended July pretty much flat. Silver did better, from a low of $33 to a high of $41, but it was still pretty tame stuff compared to the standards it set earlier in the year.

When gold stocks rise with gold, Mr Greed is at the wheel. When it's gold on its own, Mr Fear is driving.

There was a nice rally developing in broader stock markets that began in late June. But that was well and truly hamstrung by all the scaremongering that was going on over the debt ceiling issue. America, said president Obama, faced financial 'Armageddon' and would fall in to financial ruin, if the debt ceiling wasn't raised.

But did it really? Heaven knows, Obama is not the first politician to say one thing while in opposition, then do something else once in power. He won't be the last. But it still beggars belief that the same man just a few years ago (the last time this ceiling issue was raised in 2006) said this:

"The fact that we are here today to debate raising America's debt limit is a sign of leadership failure. It is a sign that the US government can't pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our government's reckless fiscal policies. Increasing America's debt weakens us domestically and internationally. Leadership means that 'the buck stops here'. Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better."

And politicians wonder why people don't believe them.

The crucial areas for the S&P 500

We all knew the US debt ceiling issue would get resolved. Over the weekend it finally was. But the markets did not give the reaction many might have hoped for. On Monday, it was a case of 'sell the rumour, and sell the news'.

The S&P 500 ended July down some 40 points. It fell another 30 points yesterday and is now in negative territory for the year. There is support here at 1,250. It is now sitting on its 52-week moving average. This is where we made a low after the Japan panic. There is a good chance we'll make a low here too. The summer is often a good time of year to be buying stocks.

But my reading of the tea leaves says that if 1,250 doesn't hold and 1,200 fails too, we could easily go as low at 1,050.

The main issue for me as wider markets try to find their feet, is once again this business of gold stocks so woefully underperforming gold. No breakout to new highs here.

Gold could correct but the outlook for gold stocks is still good

Given the run it has just had, there is a good chance that gold could correct here. That would not be bullish for gold stocks. But it would not be disastrous. Even at $1,500 gold or $1,200 anyone who can mine gold at $500 or even $800 or $900 an ounce has the potential to make so much money. The current valuations of ore bodies in the ground do not reflect that.

Even if panic over the US and southern Europe subsides and gold sells off, the longer-term picture remains bullish. Raising the debt ceiling means more debt, more mal-investment, more fiscal imprudence, and less likelihood of the debt ever being repaid, all of which portend higher gold prices.

It is pretty easy for anyone who looks at a chart of gold over the last ten years to spot a trend that will still be intact even if gold corrects 20%.

The bottom line is thi: gold stocks behave in part like gold and in part like stocks. The ideal environment for them is a period such as last autumn in which both stocks and gold are rising. The great gold stock bull market of the 1930s, for example, came after 1932 when the broader stock market was rising. The big gains of the 1970s for gold stocks also came when broader indices were rising.

While the broader stock markets are in tatters, as they are now, junior gold stocks with a few exceptions (someone makes a discovery, for example) are not going to do anything special, even if gold rises.

If markets settle down and I think there's a good chance they will, we're coming into a seasonally strong period on the back of a sell-off then gold stocks should do very well. And if the smaller companies start successfully mining and selling their gold, their numbers will be too compelling to ignore. You can find out which miners I think are most promising in my new gold report, which is out just now.

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