5 Imminent Catalysts for Gold Stocks

Like an epic stage production, this multi-year bull market for gold and silver is supported by an enormous cast of characters that each contribute meaningfully to the final masterpiece.

By "cast of characters," I refer to the extensive set of fundamental drivers and catalysts that come together -- in highly dynamic combinations -- to propel this long-term upward trend through successive periods of breathtaking market outperformance. They're far too numerous to discuss at once, so perhaps the best we can do is to hone our focus on the actors that are most illuminated under the spotlight at any given point in time.

Before I shine my Foolish spotlight on five such catalysts -- which I consider attractively poised to drive gold and quality gold mining stocks substantially higher -- it bears mentioning that the lines between catalysts for the gold price and those for related stocks are hopelessly tangled in a web of interconnectivity. Because the investment approach that I recommend for this sector is very focused on the mining shares, I try to give you the most salient catalysts for their future outperformance, without regard for the unavoidable overlap with catalysts for the underlying metal prices.

The following are, by my own estimation (and in no particular order), five of the most immediate and identifiable drivers of likely outperformance from gold's mining stocks over the coming weeks and months:

1. These earnings results will dazzle audiences worldwide
Because fourth-quarter and full-year 2010 earnings results from this highly profitable sector have yet to hit the wires, I submit that awe-inspiring rates of earnings growth are poised to brazenly slap the face of a market that continues to underestimate the group's incredible profit potential.

Royal Gold (Nasdaq: RGLD  ) kicked things off for gold last week by posting fresh new company records for both revenue and free cash flow -- and a regal 90% increase in net earnings to $18.3 million. Miners may be hard-pressed to match this royalty company's astonishing achievement of converting 87% of revenue to free cash flow in its fiscal second quarter of 2011, but Fools can nonetheless anticipate a broad and bullish pattern of rapidly expanding profit margins, copious injections of cash flow to fund strategic growth objectives, and record-smashing bottom-line results that will finally command the accolades of even gold's most stubborn objectors.

Royal Gold's average realized gold price of $1,367 per ounce provides a yardstick for the sector's fourth-quarter revenue expectations, which can be applied to estimated operating costs for your favorite miners to yield a sneak peek at hurriedly expanding operating margins. For lower-cost producers like Eldorado Gold (NYSE: EGO  ) and my top pick, Gammon Gold (NYSE: GRS  ) , operating margins will have surged to $950 or more for each ounce of gold produced in the fourth quarter, representing roughly two-thirds of operating revenue.

Investors can also look forward to further enhancements of dividend payouts becoming more likely, going along with the industry's trend of expanding profitability. Not long after I singled out Agnico-Eagle Mines (NYSE: AEM  ) as the miner most likely to pursue aggressive dividend increases, that company announced a 256% increase to its quarterly dividend (to C$0.16 per share). While that still amounts to less than a 1% annualized yield, Agnico CEO Sean Boyd encourages investors to anticipate further gains, stating: "As we continue to grow our gold output and increase cash flows over the next several years, our goal is to further increase our dividend yield."

Goldcorp (NYSE: GG  ) shares carry a similar yield, except with monthly payments that I also expect to rise substantially as the low-cost giant executes a 60% production growth spurt (to 4 million ounces annually by 2015). Goldcorp CEO Chuck Jeannes sees that growing volume coinciding bullishly with "a period of sustained cash flow expansion," helping to make Goldcorp this Fool's clear favorite among the more gargantuan miners of gold.

As you can see -- and contrary to the oft-repeated myth -- gold can pay dividends! Improving yields like these are likely to attract a fresh demographic of income-aware investors into the steadily growing fold of participants in this ongoing secular bull market.

2. Demand for gold remains in a global groundswell
Certain traders seemed to misinterpret the lyrics of Auld Lang Syne this year, forgetting their auld acquaintance with gold by triggering an abrupt liquidation to begin 2011. I view these periodic flushes of weaker, short-term-focused hands in the gold market as welcome opportunities for long-term investors to cement their positions.

Days later, a single hedge fund manager -- who had leveraged $10 million of capital into a juiced-up spread trade on COMEX gold futures totaling $850 million in value -- pulled the plug on his underwater bet. With a hint of pride in the sheer market breadth of his scantly capitalized position, Daniel Shak conceded: "Yeah, that was just me liquidating my spread position." I believe that this action further spooked a correction-wary gold market, and I personally consider it more than mere coincidence that the very next day the SPDR Gold Trust (NYSE: GLD  ) saw the largest one-day drop in its reported physical holdings since its inception in 2004.

These momentary, manic maneuverings by momentum traders, however, reveal nothing about the longer-term upward trend in worldwide investment demand for gold. Amid the sudden liquidation in New York, traders in London and Hong Kong were reportedly "stunned" by the scale of buying activity from China in January. London's Financial Times quoted one banker observing: "The demand is unbelievable. The size of the orders is enormous." The Shanghai Gold Exchange reported that Chinese gold imports during the first 10 months of 2010 surged to more than five times the corresponding level from 2009! China is on the brink of overtaking India as the world's largest importer of gold, and convenient new investment programs like the Industrial and Commercial Bank of China's Gold Accumulation Plan open the vault doors to massive potential influx of retail demand for physical gold. With gold savings options going for as little as $1.53 per day, the GAP program presents a sea of change in gold's accessibility for the masses.

The International Monetary Fund has already unloaded the 403.3 tonnes it had planned to sell, and central banks from Russia to China are still widely expected to add significantly to gold reserves going forward to improve currency diversification. Russia will reportedly add about 100 tons each year, while China may target a five-fold increase of its golden stash over the next 3-5 years.

Lastly, JP Morgan Chase (NYSE: JPM  ) this week highlighted gold's resurgent currency role by agreeing to accept gold as collateral "to satisfy securities lending and repo obligations." Gold as collateral for financial transactions represents another fresh avenue of demand for the scarce metal and is likely to convert some short-term traders into more avid long-term holders.

The looming earnings that I believe are poised to dazzle investors and the still-gathering momentum of gold investment demand worldwide form two important catalysts for meaningful upside potential from the sector's top stocks. Click here for Part 2 of this discussion, where I identify three more catalysts for your Foolish consideration.

If you're looking for another idea for a strong gold stock in the year ahead, The Motley Fool has created a new free report on "The Tiny Gold Stock Digging Up Massive Profits." In it, we reveal the little company set to profit from rise of inflation and gold prices. Get instant access by clicking here -- it's free.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Agnico-Eagle Mines, Eldorado Gold, Goldcorp, and Royal Gold. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a gilded disclosure policy.


Read/Post Comments (12) | Recommend This Article (56)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 08, 2011, at 3:54 PM, leohaas wrote:

    When Christopher Barker talks about gold and gold miners, shut up and listen!

    I am definitely not a gold bug, but everyone should have exposure to gold in a balanced portfolio. What percentage is an excellent question. Feel free to add your ideas on that one here. But when it comes to allocating the money within the sector, Chris is our go-to man on the Motley Fool.

    Thanks, Chris, for all you hard work!

  • Report this Comment On February 08, 2011, at 5:05 PM, brickcityman wrote:

    Hey Chris,

    Not sure if it evaded notice, but do you think you could chime in on this thread?

    http://caps.fool.com/Blogs/hey-tmfsinch-and-any-other-pm/534...

    Also, I've noticed you've been closing some CAPs picks on select miners recently... Are you starting to see some bifurcation that others should take note of?

  • Report this Comment On February 08, 2011, at 6:27 PM, XMFSinchiruna wrote:

    Brickcityman,

    I'll be happy to visit your blog post and comment. Sorry I missed it the first time around. :)

    As for any positions I may close in either of my two CAPS portfolios (TMFSinchiruna and silverminer), I caution Fools against trying to guess as to my rationale in any individual case.

    If you're curious about any particular ended pick, feel free to find me on my blog (link below) and ask me in my most recent post what was going through my head. Only in cases where I've also made a real-life trade would I then be unable to comment.

    http://caps.fool.com/Blogs/ViewBlog.aspx?t=01006124249416869...

    Particularly in the case of my silverminer portfolio, often I'm simply applying my discipline of locking in gains by cycling in and out of some non-core holdings. Core holdings, like those with a green check mark next to them, would remain 100% untouched in such a scenario.

    Fool on!

  • Report this Comment On February 09, 2011, at 8:06 AM, jesusfreakinco wrote:

    Good stuff Chris. Thanks!

  • Report this Comment On February 09, 2011, at 9:02 AM, jesusfreakinco wrote:

    Good stuff Chris. Thanks!

  • Report this Comment On February 09, 2011, at 4:30 PM, Jbay76 wrote:

    Hey Chris,

    Yet another good article...thanks! I was wondering if you would know of any good books, or a good book, to help investors get a better understanding of the metrics used to evaluate miners? Or PM's?

    Thanks!

    J

  • Report this Comment On February 09, 2011, at 6:42 PM, silverminer wrote:

    JBay,

    Sadly, I haven't seen very many. Maybe I should get started! :)

    Depending upon how deep you wish to delve, a geology text dealing extensively with mineral deposits, formation, stratigraphy, etc. can give a helpful background to interpreting exploration results, mine plans, etc.

    For valuation methods, there is a "Mining Valuation Handbook" that deals with the Australian industry (by a Dr. Victor Rudenno). I haven't read it, but perhaps it's one to try.

    Mining Economics and Strategy, by Ian Runge, appears targeted to mining professionals, but it covers DCF valuation techniques that investors may find useful.

    Also consider: Evaluating Mineral Projects: Applications and Misconceptions, by Thomas Torries.

    I hope that's helpful.

    Sinch

  • Report this Comment On February 10, 2011, at 1:07 PM, Jbay76 wrote:

    Thanks Sinch, it is helpful! I think I will try the geology text and Torries book and see how that goes!

  • Report this Comment On February 12, 2011, at 1:37 AM, mike2153 wrote:

    Would somebody just tell me who "The Tiny Gold Stock Digging Up Massive Profits" is so I don't have to read the sales pitch?

  • Report this Comment On February 12, 2011, at 10:00 AM, jacobske wrote:

    Christopher,

    Does the fool own shares of Rubicon Minerals? Some articles indicate it does and others don't disclose it.

    Thanks!

    Kip

  • Report this Comment On February 14, 2011, at 11:29 AM, silverminer wrote:

    jacobske,

    Rubicon Minerals was selected by my colleague Andrew Sullivan for inclusion within his "Rising Stars" portfolio. Below are links to his article regarding that selection, the Rising Star portfolio's main page, and a Q&A about that program. I hope that helps.

    http://www.fool.com/investing/general/2011/01/21/rising-star...

    http://www.fool.com/specials/risingstars/rising-stars.aspx

    http://www.fool.com/investing/general/2010/10/29/the-rising-...

  • Report this Comment On February 22, 2011, at 11:31 PM, FoolSolo wrote:

    Thanks for the insightful article Christopher. If time permits, would you kindly review my analysis on Goldcorp?

    http://boards.fool.com/1081/best-gold-stock-goldcorp-2912003...

    I would appreciate your feedback.

    Regards...

    FoolSolo

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