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Why so many gold stocks can’t keep up with the price of gold

Why exactly haven’t junior gold stocks gone up with the price of gold, asks this Canadian advisory? It has also uncovered two stocks it likes.

“What’s wrong with this picture?” The question sits opposite a chart upon which the price of gold is going up, while the price of a handpicked group of junior gold stocks goes in the opposite direction.

This leads to some serious soul-searching by Mr. Louis Paquette, editor of Emerging Growth Stocks. He takes a detailed look at the discrepancy between the runaway popularity of gold and the cold shoulder given to so many of those who seek it.

Of course, gold has taken a header the past few days, along with everything but the kitchen sink. But two days do not a trend make — yet — and we will pursue this puzzling gold story in a moment.

But the editor has also “stumbled upon a couple of interesting situations I want to share with you.” Busy preparing for a resource conference in his home base of Vancouver, Mr. Paquette was going to postpone putting out a fresh issue of his advisory altogether. But “I believe [these stocks] are attractive now and didn’t want to leave it too long to tell you about them.”

We’d better see what they are.

Half the market cap, triple the capacity

Mr. Paquette takes a particular interest in alternative energy stocks. The latest to capture his attention is Sonnen Energy Corp. (TSX/V-PWR). This is not a new start-up, but an established German firm that integrates and produces photovoltaic solar power. Photovoltaics, or PV, is a technology that uses solar cells to convert light from the sun directly into energy.

Established the company may be, but it’s no giant. At $26 million, it has half the market cap of another of the editor’s alternative energy favourites, Western Wind Energy (TSX/V-WND), with a cap of $52 million. Yet Sonnen has triple the generating capacity of Western Wind.

Sonnen also reminds him of another solar company he likes, Opel International (TSX/V-OPL), “before it bolted from $1.00 to $2.50.” The German-based firm has also been active in Canada, hiring a leading investment relations firm in Toronto and a Canadian CFO with an impressive resume in the resource industry.

The stock stood at $0.45 when this issue was published. It last traded at $0.50.

His last big deal

The second stock Mr. Paquette couldn’t wait to tell his readers about gets high marks — as so many junior miners do — because of the guy who’s running the show.

Max Resources (TSX/V-MXR) is an exploration company based in Vancouver and looking for molybdenum in Alaska and Nevada, uranium in Arizona, New Mexico and the Northwest Territories, and gold and zinc in Nevada. The president is Mr. Stuart Rogers, and this makes a difference as far as the editor is concerned. “Stu Roger’s last deal, Mag Silver (TSX-MAG), went from pennies to $16 in two years!”

The company has “great structure” according to Mr. Paquette, with $8 million in the Treasury. It has hired the same promotional team that worked on Mr. Rogers’ last project and reports regularly on its exploration plans and results. Other than the actual stuff in the ground, sound promotion and regular news are the lifeblood of exploration companies.

Max was trading at $0.60 when this issue of Emerging Growth Stocks emerged. It opened a little lower than that today (what didn’t), at $0.55.

Not exactly rolling in dough

Mr. Paquette reckons he’s been doing everything right. “Gold has reached new record highs as anticipated. And I have correctly been adding new Junior Gold picks ever since the August season lows. So we should be rolling in dough by now. Right?

“Not exactly the case,” he ruefully concludes. The editor has added six junior gold stocks to his portfolio since August. One has done very well — San Gold (TSX/V-SGR) had risen 48 per cent when Mr. Paquette went to press. “Being a producer and held longer than most, it has responded to the move in gold prices.”

But half of the six are down anywhere from 10 to 16 per cent and drag the average gain of the group down to just 6 per cent. Although some have been held only one or two months, “this is an entirely unacceptable performance considering what gold and the senior gold stocks have done since August and just since December.”

If this goes on, he adds, “the entire positive cycle for the year will have run its course and be over without delivering any joy whatsoever to shareholders.”

Mr. Paquette candidly asks: “Am I that bad a stock picker?” The answer, happily, is no. Using the TSX Venture Index as a proxy for the junior gold market, he observes that over the past year the index has risen zero per cent while the price of gold is up about 45 per cent.

Burning Candle Syndrome

Perhaps this discrepancy between the price of gold and the shares of so many gold stocks is just a temporary situation that will ultimately right itself. If so, it would resemble a similar stretch in 2004 and 2005. But Mr. Paquette doesn’t really think this is the case.

There is something else happening here. The editor refers to it as the “Burning Candle Syndrome.” The fact is, the long-term success of the junior gold companies — those that explore but don’t produce — has left them burnt out. Here’s why.

The senior gold producing stocks have more or less kept up with the price of gold because they generate cash flow and profits that add value. The juniors just can’t generate the same abundant cash flow and profits.

“Sure, they have performed spectacularly since the very beginning of the bull market in gold,” says Mr. Paquette. “And each season, until now that is, we could count on them to give us a seasonal boost. However, they have issued so many shares that they are now languishing.”

This, he thinks, is a semi-permanent condition that isn’t going to go away anytime soon. The juniors can only move up in the event of a spectacular discovery. The odds of that are a thousand to one, in the editor’s opinion, not a good risk-return ratio.

In short, the prosperity of the juniors is not tied to the price of gold, but to their own individual successes. If they don’t strike it rich, neither will investors.

“There has to be a better way to profit from the gold bull market,” contends Mr. Paquette. And while it may be a little late in the current cycle, he believes he has found the way.

The magic formulae

In the last issue, Mr. Paquette reminds his readers, he was monitoring hedging strategies and would let them know if he stumbled on the magic formulae. “Well I have found it!”

The secret is revealed in a chart that shows the TSX/V Index moving in a generally southward direction — and the Horizons BetaPro S&P/TSX Global Gold Bull Plus ETF (TSX-HGU) shooting skyward. Since it was launched last June, this exchange-traded fund has outpaced the Venture exchange by some 80 per cent!

It also left the HUI (the AMEX Gold Bugs Index) and all other ETFs in the dust. It offers double leverage — i.e., double the daily performance of the underlying index. Of course hindsight is 20-20, admits Mr. Paquette, and it’s rather late in the cycle to capitalize on this success now.

But there is a strategy to be followed. Come the next seasonal high (roughly between February and May), this ETF will come in handy again. When things turn down, its opposite number, Horizons BetaPro S&P/TSX Global Bear Plus ETF (TSX-HGD), gives investors double leverage on the way down. (The “U” and “D” in the ticker symbols simply stand for Up or Down.)

Mr. Paquette promises that he will have more on the use of these ETFs in the future. For now he figures it’s time to lighten up on stocks, build cash positions and use these funds when the time is ripe.

The obvious lesson to be learned is that what appears to be perfectly logical in the market — the price of gold must lift the price of all gold stocks — may turn out to have no logic in it at all. But then if the market were strictly logical, the experts would have had it all figured out long ago. Looking at the last few days’ results, that is clearly not the case.