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Buy Goldcorp (GG)

posted on November 5, 2009 at 2:46 pm
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The Reserve Bank of India’s purchase of 200 metric tons of gold from the International Monetary Fund, announced on November 3, is a game changer for gold and investors.

It clearly signals that major sellers of gold over the last 20 years—the world’s central banks—have become buyers again. That switch introduces a new set of buyers that are capable of soaking up a significant portion of the world’s annual gold production. And it makes me recalibrate my end of 2010 target for gold from $1150 an ounce to $1350. (For more on this the Reserve Bank of India’s buy see my November 4 post http://jubakpicks.com/2009/11/04/is-gold-the-new-dollar/ .)

At $1150 an ounce it was too late to buy into the gold play with gold already trading near $1100. At $1350 an ounce there’s still time—especially if you make your play by buying shares of a gold miner that’s showing expanding production.

Which one would I pick?

With this post I’m adding Goldcorp (GG) to Jubak’s Picks with a target price of $48 a share by October 2010.

Goldcorp reported third quarter earnings after the market close on November 4. The short-term news was that the company beat Wall Street earnings estimates by three cents a share and revenue projections by $77 million.

In the long-term, however, the more important news was, first, that the company increased its estimate of gold production for 2009 to 2.4 million ounces from 2.3 million ounces, and, second, that total cash costs for producing an ounce of gold would be $300 an ounce in 2009 rather than the $365 an ounce estimated earlier.

This is a great example of the kind of leverage investors get from gold mining stocks over owning gold itself. The company is increasing profits by producing more gold and by earning a higher spread on each ounce because of falling costs.

Add this to the general argument in favor of rising gold prices and you’ve got a solid reason to buy Goldcorp.

Gold prices have been climbing as the value of the U.S. dollar has been falling. Anyone who wants to hedge against a decline in the world’s reserve currency has been buying gold and that has sent the price upwards.

To those buyers you can now add the world’s central banks.

For the last 20 years, the world’s central banks had been sellers. In 1989 the global average for the percentage of currency reserves held in gold peaked at 32.7%. It’s been all downhill since then with central banks year by year selling gold. By the end of 2008 just 10.3% or the world’s reserves were in gold.

That trend has now gone into reverse, the buy by the Reserve Bank of India signaled. And central banks, especially developing economy central banks have a lot of catching up to do.

China has been quietly buying gold for years, doubling its holdings over the last six years. But the country still holds only 2% of its reserves in gold.

Even after India’s big buy, that country has just 6.2% of reserves in gold.

Contrast that not just to the 32.7% peak in 1989 or to the 10.3% global average at the end of 2008, but to the 60% average in Europe or the 77% of reserves that the U.S. holds in gold.

The Reserve Bank of India had 20% of its reserves in gold fifteen years ago. Before this recent buy, reserve levels had tumbled to just 3.2% in gold.

A buy the size of India’s is certainly big enough to change the supply/demand side of the global gold market. Its purchase of 200 metric tons of gold is equal to about 8% of the total annual output from the world’s gold mines.

Full disclosure: I will buy shares of Goldcorp for my personal portfolio three days after this is posted.

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15 comments

  • ajl203psu on 5 November 2009

    Hey Jim,

    What do you think about the Market Vectors–Gold Miners ETF (GDX) instead of picking one or two gold miners?

  • tivoboy on 5 November 2009

    you’re kidding, right? Is this Jim Jubaks site, or the madmoney blog?

  • Drieye on 5 November 2009

    Mr. Jubak, Calling YOUR attention to Eldorado Gold Corp (EGO), a producing miner in Turkey, Brazil, Canada, US, & China; not selling forward; buying China miner Sino in Dec. ’09, with production costs comparable to GG. http://www.eldoradogold.com/s/Home.asp

  • KR on 5 November 2009

    Jim, if your target for gold is $1350 by end of 2010, it seems like buying gold itself instead of GG, would give a better return?
    Gold’s spot price closed around $1086 on Nov5 – this would give around 25% return instead of 20% return on buying GG (from $40 to $48 for similar time frame)?

  • viwi on 5 November 2009

    Jim,

    I have to admit that this the weirdest decision I ever heard from you. I agree with KR that buying gold would be a better strategy. However, there are plenty of things you can buy right away at much better discount than GG or Gold if you seriously believe that gold will go up.

    I just correlate a bunch of stocks with gold prices to see if there is a positive tendency, and I should say that a fair amount of those stocks not have positive correlation with gold prices and outperform gold both in short and long term run.

    Anyway, I personally think that GG at this price level is a very odd choice.

    P.S. Since CVS is one of your favorites, can you comment on today’s stock slide?

  • EHG on 5 November 2009

    what do you guys think of the ETF SPDR Gold Shares (GLD) ?

  • dongarbe on 5 November 2009

    you are positive on GG due to decreasing cost of production, yet you continue to hold KGC, which has increasing costs to produce in your picks portfolio. i don’t understand why you keep KGC.

  • robert1234 on 5 November 2009

    In truth, from all my study, silver is a better buy. Gold peaked last time at 1000 and sliver at 22.00. Now gold is 1100, and silver is 17.50

    In truth, I think Jim Rogers is as near as any when he says buy a commodity Index. if gold is going up, the commodities are sure to follow.

  • robert1234 on 5 November 2009

    Answer to EHG about GLD.

    GLD would be great, except that there are persistant rumors that GLD holds a lot of paper gold, not real gold. If you want to trade GLD great ! If you want to hold real gold in a vault someplace, try CEF Central Fund of canada.

    I hold CEF.

  • denny on 6 November 2009

    Consider holding platinum. It can be bought on the London exchange, symbol ETSLF. Platinum is a precious metal which is in shorter supply than gold, and it has industrial uses such as the catalyst found in automobile conververs to reduce air pollution. Granted the our auto industry is in the doldrums but world-wide demand should be strong in the auto industry and other areas. The price of Pt is about 1300/oz down from over 2000/oz at the peak.

  • Roswell Buckeye on 6 November 2009

    Jim, does this mean Kinross will be taken out shortly. It nearly reached it’s target a few weeks ago, then fell back. Is it still a buy today? Will you keep both KGC and GG in the portfolio? Thanks.

  • wallst.finance on 6 November 2009

    Jim, I am sure you would have considered the crude shooting up as $ slides into the cost of production equation. However, have not really seen much discussion around that. Last time commodities peaked crude peaked as well resulting in higher cost of production. Would you assume a similar percent of cost increase as the end product?

  • Jim Jubak on 6 November 2009

    Let’s see if I can answer some of these. I’m disappointed in KGC. They have persistent mine problems that have cut into production. That said, I don’t think I’d sell it while gold is rallying even with those problems. Gold at the moment is correlated with stocks since it’s a falling dollar that is driving both. That doesn’t mean gold and stocks have to stay correlated. Gold is a hedge against some varieties of turmoil and slower economic growth that would send stocks lower. Gee, I’ve added a second gold stock to a portfolio with around 25 stocks. That’s an exposure of less than 10%. Gold and other commodities are also correlated, although they are at the moment. So some benefits of diversification by buying gold in addition to other commodity plays. A 20% projected return in 12 months with relatively low risk holds up prtty well to other projectd returns that I can see. Note that all projected returns for 2010, mine included,are based on some very uncertain assumptions about the economy in the second half of 2010.

  • KR on 6 November 2009

    Thanks Jim. Always appreciate the level of details and insight you provide. Even if someone disagrees with you, they can do so objectively.

  • oyz79 on 6 November 2009

    David Rosenberg made a similarly bullish argument for gold based on central bank purchases and the appearance that they now view gold as a currency http://scottsinvestments.blogspot.com/2009/11/david-rosenberg-makes-strong-case-for.html

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