first majestic silver

What's Really Happening Here ?

December 31, 2002

The following Point and Figure charts tell an interesting story.

The US Dollar has broken down

(Charts courtesy of

The Gold Price has broken up

The Dow Jones has broken down

But the $XAU has NOT YET broken up

Of course, this begs the question: What's really going on here? Normally, the shares have a much more speculative personality profile than the metal. Surely they should be leading the gold price? So, the question arises: Is the gold price leading the way to higher share prices, or are the share prices leading the way to a lower gold price?

Well, maybe the commodities are offering a clue. They have also broken up along with gold.

At face value, it looks like the commodity price behaviour is confirming the gold price behaviour, and maybe the shares are lagging.

Well, lets have a look a bit closer at some trading indicators:

Both the fast and slow stochastics of BOTH gold and the $XAU are in overbought territory. From a "trading" point of view, they are BOTH overbought.

Of greater interest is that the $XAU has not yet reached it May 2002 peak whereas gold has bettered its May 2002 peak.

So, in summary, gold bullion seems to be outperforming the gold shares and both are overbought.

Well, maybe not.

Here is a fundamental analysis I did a few months ago on Newmont Mining.

The valuation assumes that Newmont has 346.7 million shares in issue, its mines will produce at the rate of 7.5 million ounces a year at a cost of $262 per ounce of getting the gold out of the ground. It also assumes a required return on investment of 15% p.a. based on PRE TAX earnings and 9% p.a. based on AFTER (27.5%) TAX earnings. (And it also ignores the profit "cap" of Newmont's forward book)

IMPORTANT: This valuation was done a few months ago, and I have not had time to update it. However, because it is merely attempting to illustrate a principle, I don't believe that any harm will be done in using an out of date analysis.

The principle that the fundamental analysis illustrates is that at its current price of somewhere north of $29/share, Newmont's share price is factoring in a gold price of around $540/ounce.

Now, there are various studies that have been done - one by my old friend and colleague, Daan Joubert who is looking for a longer term target of $650 - $812/oz, and one by a very experienced veteran of the Gold Investment Industry - Mr James Sinclair, dated December 21st 2002 - where he is expecting a gold price circa $529/oz. "in the not too distant future". Both of these gentlemen have long pedigrees of caution and proven expertise, and I am comfortable that both are taking a "reasonable" approach on the gold price - which happen, co-incidentally, to confirm my own view, which is this:


Technically, gold bullion appears to have been outperforming gold shares in the recent past, but this does not necessarily call for a significant pull back of the gold price. What appears to have happened is that the gold shares out-ran the gold price by an order of magnitude from the time gold bottomed out a couple of years ago. As an example, Newmont's share price seems to be factoring in a gold price which is much higher than today's but which is also within the boundaries of reasonable expectation of both Messrs Joubert and Sinclair.

Fundamentally, therefore, gold still has some way to go before it catches up to the shares, and can probably be expected to continue to outperform the shares until such time as the market can see a higher destination price than $540/oz.

The pieces of the jigsaw puzzle still seem to be reflecting the picture on the outside of the box.

Post Script

From another perspective, I am expecting to see a situation emerging some time in the next couple of years when gold shares start to reflect a NASDAQ investor type approach, leading to the Gold Share Prices entering the realms of "cloud cuckoo-land" relative to their underlying valuations. However, as I have also seen one or two "reasonable" fundamental analyses which call for an eventual gold price of between $2000 and $3000 per ounce if the world is ever to get back onto some form of gold standard (which seems to be implied by Mr Greenspan's recent speech), I am comfortable that cloud cuckoo-land is still a long way off.

Finally, it may be of interest, that I have not yet seen the fundamental analysis that I would very much like to see - which was done by the Bank Credit Analyst on a regular basis until some years ago. The BCA used to do an analysis of what the theoretical price of gold needed to be in order for the market value of gold stored in Fort Knox to be sufficient to pay the US's net liquid Sovereign liabilities.

My guess is that if they ever get around to doing that analysis again, they will calculate the theoretical price at somewhere north of $3,000 per ounce.

May you all have a Happy, Healthy and Prosperous New Year.

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