24 May 2004: There is no best method of calculating valuation. They're all bad. Besides, that's what the market is for - determining values. All we do by calculating them is estimate. Just ask your accountant how reliable his or her estimate of book values is if you don't believe me.

When we say we're looking for value it usually means value the market hasn't realized yet but which we expect it will for one reason or another. However, there is no such thing as buying value if its only determinants are the past. Without consideration to the future and whether the market will realize those values the supposed process of value investing is as useful as a mechanical trading system rigidly fixed to past data; maybe even less when you compare the performance of so-called value investors in general over time.

At any rate, both processes mechanistically presume value but assume that it will be determined the same way in the future as in the past. The past is important naturally; but "only" in relation to some concept of the future where value is usually determined. There are usually clues in the past data about the company's capability to produce value in certain environments, and sometimes in the balance sheet there can be found values the market hasn't duly considered. But by and large, the value that investors perceive in the present however discovered can only be realized in the future as other investors also perceive them.

There would be no point to value investing if it didn't involve the expectation that participants will one day recognize it. Nonetheless, the best gains rarely arise from perceiving value in the balance sheet before the crowd. In fact, more often, stocks that seem to be trading cheap on a book value or PE basis simply get cheaper; the market is more interested in the future usually… specifically, those things that will "change."

The investor that anticipates real change before others do is most certainly value investing. That's what it's all about. I'm not talking about the greater fool theory here. I mean investment strategies planned on a well thought out outlook for the future. He or she is as likely to be wrong as the mechanistic value investor.

Analysts who charge that gold stocks are overvalued because they're trading at record multiples do not see $1,000 gold. If they did, value would suddenly be perceived where it wasn't before. The value in gold stocks as a sector, as far as I am concerned, is that they are selling a commodity which we believe is itself undervalued. For the sector as a whole, the changing outlook for gold prices is almost the sole determinant of value.

The fact that it is difficult to predict commodity prices, or any market for that matter, does not let the investor off the hook. Buffet may say in public that he prefers not to predict markets but then he buys silver - if he's not assessing its monetary value then he must at least be expecting some future resolution of industrial supply and demand in his favor. For there is no way to determine the value of commodities without reference to the future… they don't have a balance sheet! Whatever gains he expects to realize they are also in the future.

In my experience, when money managers say they try not to predict the market, what they really mean is that their strategy doesn't depend on the market's prognosis entirely, or sometimes at all. For instance, when we suggested that investors curtail their purchases of gold shares and even sell them in the last half of 2003, we were not making a market forecast. We were acting on developments in a way that would allow us to benefit even if they continued to go higher in the short term. If we were making a forecast I would have sold everything.

The investment strategy must embody more than one possible scenario (or outlook). That's the best way to manage risk that I know of (which could include the use of derivatives; in fact, that is their utility). It's not possible to be right all of the time but the performance of your portfolio need not suffer because of it.

The Current Outlook, 2004 Could Be Choppy

It's not always the case but I do find that the short and medium term is a tough call today. Notwithstanding this, I am still of the opinion that the timing for buying gold shares is excellent. What would you expect a gold bull to say? You know me; I'll say what I think.

Zacks.com (www.zacks.com) has been publishing my articles for almost two years. Every January they like to ask their writers to put out their favorite picks. We did this at the beginning of 2003 but I remember being cautious at the time for the same reasons as later in the year… the short term timing wasn't great. However, I felt that the medium term presented a terrific opportunity even if it started a few months later than I'd anticipated.

This year, however, I've put off publishing a gold stock issue entirely because my medium term outlook turned much less sanguine. Instead I wrote, in January, that there would be a sharp correction in 2004. Recall:

"Since 2000, however, gold prices have surged more than 60% from trough to their recent peak at $428. The leading gold share index (AMEX Gold Bugs) has surged an astounding 600% since late 2001 when the Bull Run began. By contrast, the XAU is up only 165% in that period, while the Johannesburg gold share index is up 240%. Most (bullish) gold share investors have at least doubled their money over the past few years. This has occurred amidst a general bear market in the broader equity hemispheres - one that is increasingly challenged - and a 30% drop in the value of the international reserve currency, the US dollar… the world's current, but bad money!

Precious metals mutual funds have been among the best performing funds of the market for three years running now. Even in 2003, a year when the Dow Industrials roared back 25%, gold shares outperformed most everything but the most speculative technology and foreign country funds.

This gold bull is hot. But now comes a time for many investors to make a decision in their investment strategy. Nothing goes straight up, or straight down.

And doing nothing also involves a decision. It could well be the best decision.

For, in light of our long-term view of the gold market, gold stocks are still cheap today. However, gold stock corrections - when they come - can be steep, particularly at the early stages of a developing bull market. We expect reversals in many markets during 2004, and consequently, an interruption to the gold share bull market sometime after the first quarter or maybe sooner" - January 2004.

First time investors: would probably never buy a dip in gold stocks like this. If they did I would definitely commend them; but if they weren't already long gold after the breakout in the HUI last year it is not likely that they would view this as a buying opportunity. Not enough has changed - the inflationary trend was already put in place and if they didn't see it then they aren't likely to see it when the sector is reeling. There is more evidence of inflation, true, but perhaps not enough to get the blind in gold stocks when they're falling is all I'm saying.

Notwithstanding, there is the view that some of the big boys, having missed it, orchestrated this latest correction just to get on board. I won't rule it out. But if it's true the correction should be over like now. At any rate, all I can say if you don't believe is that this is the time to delude yourself into believing… the risk of being wrong on the entry point has washed out considerably.

This is the time to acquire a core gold stock position if you haven't already got one.

As gold prices rise to $1,000 it is common for the earnings of leveraged producers, and hence their stock prices, to rise even faster than gold. Whereas in a sector recession the leveraged producers fall fastest perhaps because they have the most trouble managing their costs to begin with, a gold bull market tends to have the opposite effect.

The Most Sizzling Growth Story

Companies like Wheaton River (WHT) have produced exceptional growth. From $30 million in annual sales prior to 2002 Frank Giustra et al have grown this company to produce more than $300 million in revenues only two years later. In that same short period reserves and production have essentially grown from nothing to more than 5 million ounces and 500,000 ounces respectively. The latter is expected to double again by 2007.

But shares outstanding have grown enormously - from under 100 million in 2001 to almost 800 million today - so that on a per share basis the figures don't stand out as much. Without taking anything away from this outstanding accomplishment it isn't what we're talking about when referring to growth.

We're looking for those companies that can sustain that kind of growth in their per share values. It's true that Wheaton's shares (WHT) have performed really well despite this method of growth; but that owes to the fact that they started with nothing.

Ed Bugos
Editor - The GoldenBar Report
www.goldenbar.com

May 24, 2004

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