Forget gold – buy this rare metal instead

What's the best mining stock to buy right now? Well, if you read the latest mining sector study by RFC Ambrian you might say a gold miner. Because Ambrian has just pointed the way to a huge story that could send the gold price into the stratosphere.

It's starts with the Nixon Shock the moment in 1971 when Richard Nixon cancelled the direct convertibility of the US dollar into gold. The US was burdened by the cost of the Vietnam War. And Nixon reckoned that by closing the gold window', he could strengthen his hand. In an instant, gold ceased to be classified as real money. And for a long time it stayed that way.

But gold could be about to be re-instated as pillar of the global financial system. It turns out that the Bank of international Settlements (BIS) the global central bank to all other central banks has been debating whether to reinstate gold as a Tier 1 asset. What does that mean?

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Well achieving Tier 1 status would credit gold with the recognition it's been denied ever since Nixon closed the gold window in 71. It would mark official recognition that gold is real money again. And that could mean that banks will be encouraged to buy gold to re-establish trust in the financial system.

So you should buy gold miners, right? Well not so fast

Commodity prices are merely at a bump in the road

Once the world's top bankers think that gold is a risk-free asset then I'd say you should be getting scared. But if you are a gold bull, one conclusion of the fascinating mining sector study by RFC Ambrian is that you should own gold mining shares rather than the physical commodity. And they do make a few interesting points.

While the gold price has held firm, the shares of gold miners have languished in the last few years. This is partly due to a general worldwide aversion to equities, but also because of the growing trend towards resource nationalisation that I have previously highlighted in this column that's one reason to be cautious about gold mining stocks.

And resource nationalisation is not confined to gold. Nor is it confined entirely to poorer countries with volatile political establishments and a weak judiciary. As RFC Ambrian points out, "when poor, mineral-rich countries see Australia introduce a Mineral Resource Rent Tax it is not surprising that they will decide to follow suit" ironically harming many Australian-owned foreign miners in the process.

Despite this, RFC Ambrian is still quite upbeat about the mining sector calling the recent softening of commodity prices "merely a bump in the road of the commodity super cycle". It re-iterates the trend towards urbanisation in China and the developing world that is driving demand for metals, and it shows that these countries still have some way to go before they reach the level of city dwelling seen in the Western world.

Supply now equals demand in commodities

The study also points out that the retreat in commodity prices this year has been far from uniform and, across the board, quite slight. The copper price, traditionally the bellwether of the sector, has seen its price retreat from a peak of $8,610/t in January to $7,650/t today, which is hardly a crash, and still leaves the price far above the $1,500-$2,000 that prevailed ten years ago.

There are also some signs that prices are rallying. Although it is always hard to distinguish between end-user demand and a restocking of the supply chain, the iron ore price is up 40% since its January low.

The free market has worked well. Money has been thrown at exploration and mine development and supply has caught up with demand in most commodities.' But this accelerated production is fast depleting resources, making it increasingly difficult and expensive to meet demand. This should mean that prices stay high, but equally that costs of production will also stay high. Rising costs, along with the political risks, are the main reasons to treat the sector with due caution.

In terms of individual commodities RFC Ambrian favours gold, uranium, zinc and mineral sands while its preferred shares are Mandalay Resources (TSX, MND), Base Resources (ASX, BSE), Euromax Resources (TSX, EOX), Papillon Resources (ASX, PIR), Deep Yellow (ASX, DYL) and, on the UK's AIM market, Ortac Resources (OTC), Ormonde Mining (ORM) and Emed Mining (EMED).

But what caught my eye were RFC Ambrian's long term commodity price forecasts. These mostly predict a decline from today's levels gold to $1,400/oz, silver to $22/oz. and copper to $2.95/lb for example. That's another reason to be cautious about buying gold miners.

An exciting UK tungsten prospect

That's not the case with all commodities that RFC Ambrian reviews. There are a few commodities that look set to enjoy higher prices over long term. Two of these are potash and tungsten. Here in the UK, two projects are under way to produce these valuable commodities. And these projects look to be free of the political risk that is unnerving investors elsewhere. Why?

Because the UK government likes these projects and the real' jobs that they provide, so is not putting obstacles in their way. While investors are getting excited about iron ore in east Africa, gold in Patagonia and copper in central Asia, it may just be that two of the very best projects are right here at home. Short supply of tungsten and high prices has made a site here in the UK very attractive to one mining company in particular. For more on this see December's edition of Red Hot Penny Shares.

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This article is taken from Tom Bulford's free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.