News Analysis date published New: 
Tuesday, July 17, 2012 - 13:00
New Date created: 
Tuesday, July 17, 2012 - 13:00
New Date last updated: 
Tuesday, July 17, 2012 - 13:00

This Simple Chart Says Gold Stocks Could Soar

Tuesday, July 17, 2012 - 1:00pm

A huge disconnect has formed in the price of gold stocks...

In the past 10 years, gold has been in one of the market's longest bull runs. Since 2002, the price of gold has gone from an average of $303/oz to $1,586/oz today -- a remarkable 424% gain...

Normally, this would be good news for the companies that actually dig the stuff out of the ground. As the prices of precious metals rise, the stock prices of the companies that mine those metals often go up with them.

But gold stocks haven't been as fortunate.

This chart shows the return of gold compared with the Market Vectors Gold Miners ETF (NYSE: GDX), a proxy for mining stocks. As you can see, gold stocks have significantly underperformed gold during the past year. If you look back over a five-year period, the difference is even more striking.

We've seen the prices of gold bullion and gold equities get completely out of whack several times in recent years. Normally, it's when the market suffers a sharp sell-off and investors dump all their equity holdings out of fear.

But this disconnect normally doesn't last very long. When the market regains confidence, the divergence tends to correct itself.

For example, we saw a similar situation back in November 2008. Back then, stocks of all shapes and sizes were plummeting amid the financial crisis, with mining stocks suffering an overdone 60% sell-off. But gold stood its ground.

The imbalance didn't stand long. As you can see from the chart below, once the market regained its confidence, gold-mining stocks came racing back.

Back then, shares of GDX fell to below $18 a share. Within seven months, the stock gained 138% before topping out at more than $43 a share.

If the economy starts to gain some momentum, gold stocks could be primed for another double or triple-digit run.

Risks to Consider: Gold stocks have been underperforming because rising energy prices have increased production costs, cutting into the profit margins for most mining companies. If energy prices continue to march higher, or if the price of gold suffers a sharp sell-off, gold stocks could fall even more.

Action To Take --> Historically, disconnects between gold and gold stocks have signaled a major buying opportunity for investors looking to profit from the yellow metal. An exchange-traded fund (ETF) like GDX lets you invest in a handful of the market's biggest mining stocks without exposing yourself to the investment risk of a single mining company.

Austin Hatley does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.