Gold Stocks: Am I Wrong?

Last week was playing out just dandy until about 7:30 am on thursday.  That’s when the stock market opened and the gold stocks I owned fell along with the rest of the market.

Since the peak on Wednesday afternoon Jaguar Mining is down $1.10, or 16.4%.  OceanaGold is down 0.65, or 23%.  Argonaut Gold is down 14%.  Lydian International is also down 14%.

Now I could write a post about how unjustified this is.  How these 4 stocks, and gold stocks in general, never began to price in a gold price of $1500/oz, let alone $1800/oz.  And about how in the case of OceanaGold and Jaguar Mining, the stock price is significantly lower then it was when the gold price was $1000/oz.

All of this is true, but its not necessarily helpful going forward.  What is helpful is to assess the situation and determine if I am best to stick it out, or admit that maybe I am wrong about the direction of gold stocks.

I’ve spent most of the weekend pondering the reasons for gold stocks to go up and the reasons for gold stocks to go down.

I think that the basis of all the arguments for and against come down to the causation of the rise in the price of gold.  Now maybe I am simplifying the situation too much, but think you can narrow it down to two contrasting views of why gold is going up.  Each view leads to a drastically different opinion of what will happen to the price of gold (and the price of gold stocks) going forward.

These views are:

1. Gold has gone up on the expectation of Federal Reserve balance sheet expansion
2. Gold has gone up on fear of the disintegration of the Euro and the EU

The first argument is what is being bandied about the most over the weekend.  Gold, and thus gold mining stocks, were pricing in QE3 and that didn’t happen.  Operation twist is not quantitative easing.  There is no expansion of the Federal Reserve balance sheet and there is none on the immediate horizon.  So if the price of gold is a function of the Federal Reserve balance sheet, then gold must return to pre-QE3-anticipation levels.  A good starting point would be $1400-$1500/oz.  Or perhaps gold goes lower if it overshoots to the downside or if the Fed begins to gain credibility in its balance sheet management.

The second view was invoked quite often over the last month, but it seems to have fallen on deaf ears in the last couple of days.  That’s because it doesn’t fit the evidence.  the EU is still a mess.  The price of gold is falling precipitously.

So does the move of the last two days mean that the Fed watchers are right and that the run in gold is over until there is at least some evidence of QE3 on the horizon?  I’m not willing to say that yet.  I’m going to re-quote what I paraphrased from Donald Coxe a couple days ago:

The investment case for gold lies in the 500 million people living within 17 different countries that have their savings, pay cheques, and pensions tied to a currency that was based on a theory and seems by the day to have less of a tie to reality.

This argument still holds a lot of water in my mind.  There is still no good way to resolve the situation in Europe.  As long as this is the case, gold should continue to have a bid.  And I can’t see how this will stop being the case.  There simply isn’t the money available to resolve the debt issues of the PIIGS.  The only solution seems to be the extradition of at least some of the PIIGS from the EU.  That is going to be such a messy process, with so many potential pitfalls for both the sovereigns and the banks, that I can’t see how gold would fall in such an environment.

But I remain open to the possibility that I am wrong.  I will be watching the price of gold over the next few days and if the weakness continues I will have no choice but to cut my positions.  In that regard, I will likely lighten up on OceanaGold first.  Both Jaguar Mining and Argonaut Gold are in somewhat envious positions right now.  Jaguars mines are in Brazil, while Argonaut Gold has its mines in Mexico.  Both the Real and the Peso have been falling lately.  This will help bring down Q3 costs and even more bring down Q4 costs.

OceanaGold operates in New Zealand, and while the currency there has began to weaken, it is still above the average levels of Q2.

Lydian I will continue to hold because the story there is really less attached to the price of gold then in the other cases.  Lydian is moving forward an exploration project that will be profitable at much lower gold prices.  At some point the company will be taken out.  So that one I will hold as well.

We’ll just have to see how this next week plays out.