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Go for Gold

Paul Sullivan

Okay. The world is still right side up…for now. As I write it looks as if the U.S. Congress will pass the $700 billion bailout scheme and, if George Bush is right, "this sucker" (i.e. the economy, the free world, etc.) won't go down.

It may be a little difficult to concentrate over the foreseeable future — it's hard to think over the din of all those talking heads chewing up the scenery. But it's a good time to think.

One of my favourite aids to thought is to consult a wise man (or woman) as a means of kick-starting my brain, and last week I had a chance to talk over the economic meltdown with Milton Wong, Vancouver's eminent financier and philanthropist. His advice? Buy Canadian gold companies. They are relatively inexpensive, and demand has to grow as investors look for a port in the current storm.

Some investors will prefer to buy the commodity itself. Nothing like a few gold bars in your pocket to keep you from blowing away in the mighty wind of a financial meltdown. A number of commentators who take the historic long view think gold is undervalued. We all forget that in 1977, gold was $850 an ounce. Dan Ferris, who writes the commentary Extreme Value, notes that if gold were to repeat its 1971-80 performance, it would hit $6,000 an ounce this year!

While that may induce you to load up on the Krugerrands, Ferris cautions that it's not a good idea to check the gold price everyday. "No one knows where the gold price will go — not you, me, or anybody else," he demurs.

Another key note from Ferris: don't bother with a gold share ETF: "Sooner or later it'll become clear the ETF is not gold. It's a stock. When panicking investors need to liquidate securities portfolios, they'll sell the gold ETF with a mouse click, the same way they'll sell Google. Once the gold is in your hands, you're less likely to panic."

Okay, so why recommend gold stocks? Because, as John McCain might say, the fundamentals are strong — not to mention this little Wall Street panic that's currently underway. Traditional demand for gold was already increasing before the meltdown, and supply was not increasing at the same rate.

The gold survey published September 18 by the London-based precious metals consultancy GFMS forecast a rally well into the $900s later this year, with Philip Klapwijk, Executive Chairman of GFMS, arguing that positive price drivers will outweigh the negatives.

For instance: mine production is not growing. For 2008 as a whole, production is forecast down 2 percent over 2007.

Scrap supply has dried up and is not likely to recover until the price hits $950.

The central banks are holding onto their gold supplies: net official sales are down 26 per cent for the first half of 2008. (More on that in a minute).

That old standby, jewelry demand, is starting to recover after a 24 per cent decline in the first half of 2008. India, the world's largest gold jewelry market, reports bullion imports reached record highs in August.

If you're worried about further declines in commodities, even precious metals, GFMS argues that following the steep declines that have already happened, the downside is no longer that great. GFMS is convinced that investors will remain concerned about the stability of the US economy, which will enhance gold's status as a safe haven, and a further appreciation of its price.

Which brings me back to Canadian gold companies. You may not want to spend $900 an ounce, which is what gold is trading for as I write, then sit tight and hope it goes up to $6,000. Why not just wait for a UFO to stop by your house and beam you up to the planet of milk and honey?

But the major Canadian gold companies are all bargains right now. And a number of them are in the right position to increase production as demand increases.

For example: Goldcorp. Inc. (TSX/G) closed on September 26th at $34.45, well off its 52-week high of $52.48. Goldcorp is rated as a top pick by RBC Capital Markets analyst Michael Curran, mainly because of its new Penasquito mine in Mexico.

Then there's Kinross Gold Corp., (TSX/K) which closed on September 26th at $17.03, more than $10 off its 52-week high of $27.16. The big news at Kinross is that it has scooped up Aurelian Resources Inc. and its main asset, the Fruta del Norte deposit in Ecuador, reputed to be the world's best undeveloped gold deposit.

While there are 17.3 million ounces in the ground, the ground is in Ecuador and there may be some complications — i.e. Ecuador has no established mining legislation, and no one can really say for sure how it will go. This uncertainty allowed Kinross to acquire Aurelian for the low, low price of $850-million. There were no competing bids from the monsters: Barrick Gold Corp. and Newmont Mining Corp. The consensus seems to be they will wait and see how Kinross does, and if necessary, acquire Kinross.

At any rate, Kinross performs well even without its legendary acquisition, providing investors with a 5-year return of 11.55 per cent, which these days is a comfort.

Then there's Yamana Gold (TSX/YRI), once the darling of CNBC's Jim Cramer, which, like the other examples, has been down at the heels lately, trading at $9.25, off its 52-week high of $19.79. Yamana has the lowest costs of the group, and it rates a sector outperform rating from analyst Curran. And while its one-year yield has been rocky, it's given shareholders a 36.23 per cent return over five years.

I don't think you can go wrong betting on the capacity of these three to rise to the challenge. When the holder of the world's second largest gold reserves, Germany's Bundesbank announces, as it did on Monday September 28, that it has no plans to sell any gold for the next 12 months, you've got think that the supply of the shiny stuff has tightened even further — these companies are in a position to meet the rising demand, while their costs are relatively low.

Paul Sullivan is a longtime Vancouver journalist and president of Sullivan Media. He also writes for The Globe and Mail.

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