Gold Stocks: Still Likely to Shine

S&P's overall fundamental outlook for the subindustry is positive, implying the potential of positive price performance in the months ahead

The S&P 1500 Gold index has seen a jump in its trailing 52-week relative performance ranking, possibly the result of rising inflationary concerns and a weakening U.S. dollar as a result of the Fed's recent double-barrelled cut in interest rates. Year to date through Sept. 21, the subindustry index (which consists of only one company: Newmont Mining (NEM; $48) rose 5.3%, vs. a 7.7% advance for the S&P 1500 index.

During the past 13 weeks, however, the subindustry jumped 20.8% compared with the market's rise of 1.2%. In 2006, the Gold index fell 15.4%, vs. a 13.3% advance for the broader market.

Doing a little research in our database, I found that S&P follows analytically three additional gold mining companies not included in the index: Barrick Gold (ABX; $40), Lihir Gold (LIHR; $33), and Randgold Resources (GOLD); $30).

Expectation for Another Increase

Leo Larkin, S&P's metals and mining analyst, continues to have a positive fundamental outlook on the group, though the majority of companies followed by S&P do not carry buy rankings. (Barrick is the sole gold miner followed by S&P to carry a buy recommendation; Newmont and Lihir are ranked hold, while Randgold carries a sell ranking.) Larkin bases his view on S&P's expectation for another increase in the price of gold in 2007; he looks for higher sales and earnings for this group this year, even though production volumes are likely to decline from 2006 levels.

While the price of gold has been rising steadily since 2001 and reached the highest yearly average level in 2006 since 1980, S&P believes that the yearly price will increase again in 2007 and 2008, for several reasons.

First, S&P believes the economy in 2007 and 2008 will slow relative to 2006 GDP (gross domestic product) growth. With the Federal Reserve easing monetary policy, in S&P's view, lower short-term interest rates reduce the opportunity cost of holding gold as an investment and should allow gold to rise even if other commodities decline in response to slower economic growth.

Production Remains Stagnant

Second, in spite of the higher gold price, global production has been stagnant for the past 10 years. The low level of gold prices in the late 1990s led to a drop in exploration and large new discoveries. According to data compiled by Gold Fields Minerals Service, a British metals consulting firm and publisher, global output increased at a 0.8% compound annual growth rate (CAGR) from 1997 through 2006, while consumption rose at a CAGR of 1.5%.

Larkin believes that production will remain stagnant for the balance of the decade, as old mines are becoming depleted and are not being replaced to the extent needed to lift output. That, combined with rising demand, should cause the chronic gap between production and consumption of gold to widen further, in S&P's view, helping to lift the price of gold.

Third, Larkin believes that greater volatility of the major world currencies will likely increase the demand for gold as a monetary reserve asset. In addition, S&P believes that the U.S. dollar is in a bear market. And S&P believes that China and other countries that hold a large portion of their foreign exchange reserves in the U.S. dollar will ultimately diversify out of the dollar and into other currencies and gold.

So there you have it. The group's strong relative strength is improving, and S&P's overall fundamental outlook is positive, implying the potential of positive price performance in the months ahead.

Industry Momentum List Update

Here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of sub-industries in the S&P 1500), along with a stock with the highest S&P STARS (tie goes to the highest market value).

Subindustry Company S&P STARS Rank Price (9/21/07)
Auto Parts & Equipment Johnson Controls (JCI) 3 $117
Commodity Chemicals Lyondell Chemical (LYO) 3 $47
Computer Hardware Apple Inc. (AAPL) 4 $144
Construction & Engineering Jacobs Engineering (JEC) 5 $77
Construction & Farm Machinery Trinity Industries (TRN) 5 $36
Diversified Metals & Mining Freeport-McMoRan Copper (FCX) 3 $109
Fertilizers & Agr. Chem. Monsanto (MON) 3 $79
Integrated Oil & Gas Exxon Mobil (XOM) 4 $92
Internet Retail (AMZN) 2 $91
Oil & Gas Drilling Noble Corp. (NE) 5 $51
Oil & Gas Equip. & Svcs. Schlumberger (SLB) 5 $106
Oil & Gas Refining & Mktg. Valero Energy (VLO) 4 $71
Steel Nucor (NUE) 4 $60
Tires & Rubber Goodyear Tire (GT) 3 $29

Source: Standard & Poor's Equity Research

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