The Small-Cap Investor’s Guide to Gold

A short guide sent to me by email. I thought I would share it.


With market volatility on the rise, scores of investors have been turning their sights to gold. Typically, gold and small-cap investing don’t have much overlap – but that’s not true when it comes to junior mining stocks. These tiny companies benefit from the price increases in gold, but they also offer the value-driven analysis of a typical small-cap. And right now could be the perfect time to buy shares in mining companies – here’s why…

When the proverbial fecal matter hit the fan during the week of May 3, one asset shined above all others. It was the humble yellow metal, gold, doing its part in times of panic and crisis. It held up. On May 7, gold closed above $1,200 for the first time in five months — up more than 2.5% during a week in which U.S. stocks endured a freefall. Just five days later, it hit an all-time high of $1,243.10. And the largest physical gold fund recorded its largest inflows since early 2009.

Of course, buying gold all the time is not really an investment strategy. If you bought gold in the 1980s and 1990s, your return was abysmal. So, as with all assets, there are times when gold is a really good buy and there are times when it is not. Sounds obvious, but many people seem to want to think that gold is an exception to the order of things. It isn’t.

But how do you know if gold is cheap? Well, intelligent people usually advance a couple of arguments.

One is that on an inflation-adjusted basis, gold is 30% less than its all-time high in 1980. Okay, that’s true, but it’s not particularly timely because by that measure gold has been cheap for three decades. And who’s to say that the 1980 gold price is a benchmark we should pay attention to, anyway? By that way of thinking, the NASDAQ is a bargain, too, because it trades at a big gap from its 2000 high. But is it? I think not.

Another point advanced by the “gold is cheap” crowd is the old monetary base argument — that gold’s price tends to track the monetary base over long periods. The monetary base is essentially bank deposits and currency. It’s like the seedlings of inflation.

This argument is a little more interesting. Yet, as the government has added huge piles to the monetary base in the last year or so, the gold price has responded in a muted way. This next chart shows what the gold price would have to be to “catch up” to the monetary base.

QB Partners, a New York-based hedge fund, really likes this argument. QB writes: “The graph shows visually how much U.S. dollar purchasing power has been lost. We think gold is cheap by a factor of almost 7 times.”

If a gold price of $7,000 an ounce doesn’t strike you as implausible or absurd, QB’s next comment might. QB says the chart “does not necessarily imply a target price for spot gold. The gold price could move higher than that if it experiences a blow off top, like all other bull markets tend to do before exhausting themselves.” So, $7,000 an ounce, you see, is just some kind of base case.

Maybe it’s not so implausible. Strange stuff happens all the time in markets. If I had told you on May 6 that Accenture — a $40 stock with a $29 billion market cap — would trade for a penny a share the next day, you would have thought I was nuts. Yet, on May 7 it did just that, if only for a second.

But the gold market is different because it’s so small. Even a small amount of interest in gold will send it up a lot. Just imagine if people decide a small sliver of that tall bar of financial assets should be in gold. We’re talking about some serious pressure on the gold price.

That’s a nice scenario, but I don’t invest in nice scenarios. I invest where I can find value. Speculative upside is a plus. Those kind of stocks give you that added juice on the price of gold. A cheap gold stock is even better – that’s why I’m recommending that my readers pick up gold miners, not just gold itself…

By Chris Mayer