Don't Miss the Epic Gold and Silver Explosion

If absence makes the heart grow fonder, then those intrepid gold and silver investors who stood valiantly through the sector's latest corrective slump will harbor a very special fondness for the sudden upside explosion that's occurring in precious-metal equities. From the world's largest producers, to the multitude of impaired microcap explorers, such resounding strength has been absent from these stocks for quite a long while now.

Have a look at the following one-month chart, which shows the gold and silver miners breaking out in dramatic fashion as the SPDR Gold Trust (NYSE: GLD  ) and the iShares Silver Trust (NYSE: SLV  ) have advanced by 6% and 14%, respectively. Not surprisingly, the late-summer rally gathered additional steam this week after Federal Open Market Committee minutes exhibited greater support for a third round of quantitative easing than had been seen from prior sessions.

GLD Chart

GLD data by YCharts

Since I pointed out just last week that IAMGOLD (NYSE: IAG  ) shares had reached a ludicrous valuation of just $103 for each resource ounce, the stock has already advanced 16%. First Majestic Silver (NYSE: AG  ) has surged 12% since I affirmed that this growing silver producer still has the magic touch. But for all the  remarkable strength of this sudden precious breakout, what if I were to suggest to you this is merely the opening salvo of a major move that will take gold and silver to brand new highs and likely well, well beyond?

This is still just the beginning
Now that gold and silver have been on the ascent for more than a decade, and outperforming nearly everything in sight, it may be difficult for some to imagine that we could yet remain closer to the beginning than the end of this secular bull-market run (in nominal terms). But that's exactly what renowned gold expert Jim Sinclair proposes when he pledges in no uncertain terms that "gold will go to and above $3,500." Coming from the very same man who precisely called the prior peak in gold back in 1980, and correctly predicted that gold would reach $1,650 when an ounce cost less than $300 in 2001, Sinclair's revised target of $3,500 is not something I would advise skeptics to casually dismiss.

Referring to the intentional manipulation of gold and silver that even futures regulator Bart Chilton has vocally corroborated as a serious source of concern, Sinclair confidently declares: "The battle to stop gold has been lost." Now that the upward secular trend has been reignited by resilient physical demand, resurgent capital inflows, key technical breakouts, and the obvious outlook for further fiat-currency debasement, gold and silver are poised for a meaningful run to the upside that will translate into long-awaited gains from the relevant mining and exploration equities.

The visible exodus of investment capital from all things silver and gold over the trailing 15 months -- which dragged equity valuations to a shocking 15-year low when measured in relation to the gold price -- now turns to the advantage of the longs as the weaker hands have been thoroughly flushed from the market. Structurally, gold and silver remain in pristine condition to continue their secular run, since they remain severely underrepresented within prevailing asset allocations. Consider the following statement by Robert Fitzwilson, founder of The Portola Group:

Gold and silver remain ridiculously undervalued. There is no bubble. Anyone who advocates investing in these resources is immediately attacked as being on the fringe. The valuations of the premier companies reflect that. There is virtually no institutional exposure when one looks at the aggregate financial assets.

When gold and silver exposure truly goes mainstream
When it amassed an unconventional 5% allocation to physical gold bullion last year, the University of Texas endowment roughly quintupled what economist James Rickards considered a typical gold allocation among major institutions of between 0% and 1.5%. During the 15-month correction that followed before this August awakening, furthermore, I suspect the average institutional allocation will have dipped toward the low end of that range.

I find it fascinating to consider that gold can have achieved such noteworthy trailing gains even before a typical institutional allocation moves beyond the 1% range! Meanwhile, in a world where U.S. Treasury bonds offer negative yields, and the world's paper currencies are locked in a dangerous game of competitive devaluation, does this prevailing average gold allocation properly reflect gold's resurgent role as a time-tested anchor to the global financial system? I think not. So take your pick as to what you think that average allocation will be as gold approaches its ultimate peak. The important point is that from the present status quo of virtually nonexistent allocation to gold, even a modest advance to 2% or 3% of invested capital would translate into tremendous gains for the precious metals.

A few exceptions can be found to the broader pattern of institutional indifference toward silver and gold, and I believe those fund managers making early inroads into precious metals offer a collective glimpse of the sort of market penetration we can expect to witness far more commonly than we do today before any notion of a bubble can be seriously posited.

After increasing the gold allocation in PIMCO's Commodity Real Return Strategy Fund from 10.5% to 11.5% in recent months, portfolio co-manager Nic Johnson hailed gold as "the currency without a printing press." Adding more than 4.5 million shares of the SPDR Gold Trust during the second quarter, John Paulson's gold position now accounts for fully 44% of the firm's U.S.-listed equity holdings. Calling gold miners "historically inexpensive," Paulson also picked up 4 million shares of NovaGold Resources (NYSE: NG  ) during the second quarter. And proving yet again that the investment world sorely misinterpreted his 2010 characterization of gold as a bubble, billionaire investor (and newlywed-to-be) George Soros more than doubled his gold position during the second quarter to reach 884,400 shares of GLD (with a current market value of $143 million).

With gold trading above $1,660 per ounce even before institutional and retail investors have forged any kind of meaningful foray into the sector with reasonable allocations to either physical bullion or mining equities (ideally both), this Fool has zero trouble imagining a gold price beyond Jim Sinclair's target of $3,500 per ounce as allocations adjust to reflect the resurgent role of gold and silver as critical assets for wealth preservation during periods of economic and currency distress. While I keep my own gaze set upon my interim price target of $2,250 per ounce, I will by no means be inclined to reduce my own allocation to precious metals until far higher prices prevail.

To help pare down the list of potential vehicles for increasing one's investment allocation to gold, download The Motley Fool's special free report "The Tiny Gold Stock Digging Up Massive Profits." Our analysts have uncovered a little-known gold miner that we believe is poised for greatness; find out which company it is and why we strongly believe in its future -- for 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 First Majestic Silver and IAMGOLD. 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 disclosure policy.


Read/Post Comments (9) | Recommend This Article (36)

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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 August 26, 2012, at 4:30 AM, jayw999 wrote:

    Chris, just a note that the paragraph starting with "A few exceptions " is in there twice, separated by 2 other paragraphs. --Jay W

  • Report this Comment On August 27, 2012, at 1:23 PM, dragonmonkey wrote:

    "on the ascent for more than a decade, and outperforming nearly everything in sight" = bubble

  • Report this Comment On August 27, 2012, at 1:36 PM, johnybottom wrote:

    dragonmonkey: I might be mistaken, but the standard definition of a "bubble" implies more of a "mindset" than anything else. Chris goes on to explain that gold equities are severely under-represented in the investing world as a whole, which undermines your suggestion that prices are currently in a bubble.

  • Report this Comment On August 28, 2012, at 1:47 PM, FoolishForFools wrote:

    Chris, can you comment on or perhaps even write an article about the news coming out of Aurcana- thanks.

    http://finance.yahoo.com/news/aurcana-corporation-announces-...

  • Report this Comment On August 28, 2012, at 8:41 PM, skypilot2005 wrote:

    On August 28, 2012, at 1:47 PM, FoolishForFools wrote:

    "Chris, can you comment on or perhaps even write an article about the news coming out of Aurcana- thanks.

    http://finance.yahoo.com/news/aurcana-corporation-announces-...

    Ditto here, Sinchi.

    Fellow Fools,

    Check out Sinchi’s stock picks on his Foolish Blog. Look at AUNFF.

    This is a prime example of how I’ve made a lot of money over the years following Sinchi.

    In one of my real life portfolios, I have a cost basis of .79 for AUNFF and I am up 25.71% on

    that pick alone thanks to Sinchi.

    Remember that the next time someone comments about Sinchi missing one at that moment. I have

    10 I’ve gained on to everyone I am not ahead on, YET.

    Thanks again Sinchi for all the great D. D. you do.

    Sky

    Your grateful Web Link Assistant

    I own a ton of AUNFF

  • Report this Comment On August 28, 2012, at 9:13 PM, skypilot2005 wrote:

    I just took a look back:

    I started buying AUNFF in Feb. of 2011 thanks to Sinchi @ .7047.

    Sinchi picked it on his blog as a top pick in Feb. 12’ @ .74

    http://caps.fool.com/player/tmfsinchiruna.aspx

    He also, provides ongoing coverage:

    http://www.fool.com/investing/general/2012/06/04/aurcanas-si...

    6/4/12

    Aurcana's Silver Triumph and Golden Surprise

    An additional bonus is that I picked some up for #4’s portfolio, as well. Her cost basis is .89.

    Fellow Fools: I just had to get that off my chest.

    There. Now I feel better.

    Thanks again, Sinchi.

    Sky

  • Report this Comment On August 29, 2012, at 11:01 PM, MHedgeFundTrader wrote:

    One of my best calls of the year was to plead with readers to avoid gold like the plague, periodically dipping in on the short side only. The barbarous relic has been in a bear market since it peaked at $1,922 an ounce at the end of August last year. Gold shares have fared much worse, with lead stock Barrack Gold (ABX) dropping 36% since then and the gold miners ETF (GDX) suffering a heart rending 43% haircut.

    However, the recent price action suggests that hard times may be over for this hardest of all assets. Despite repeated attempts, the yellow metal has failed to break down below the $1,500 support level that I have been broadcasting as the line in the sand.

    It has rallied $170 since the last try a few weeks ago. (GDX) has performed even better, popping 20%. For the last month, the entire precious metals space has traded like it was a call option on global quantitative easing (see yesterday’s piece). Dramatically worsening economic data is increasing the likelihood of further monetary easing generating a nice bid for gold.

    Now the calendar is about to ride to the rescue as a close ally. It turns out that in recent years, there has been a major seasonal element to the gold trade, almost as good as the November/May cycle that drives the stock market. Gold typically sees a summer low. Then traders start anticipating the September Indian wedding season when the purchase of gifts and dowries become a big price driver. That explains why India, with a population of 1.2 billion, is the world’s largest gold buyer.

    Next comes the Christmas jewelry buying season in western countries. That is followed by the gift giving and debt repayments during the Chinese Lunar New Year, during which we see multi month peaks in the yellow metal. That is exactly what we saw this year. The only weakness in this argument is that a slowing Chinese economy could generate less demand this time.

    These are heady inflows into such a small space. All of the gold mined in human history, from King Solomon's mines, to the bars still in Swiss bank vaults bearing Nazi eagles (I've seen them) would only fill 2.5 Olympic sized swimming pools. That amounts to 5.3 billion ounces, about $8.6 trillion at today's prices. For you trivia freaks out there, that is a cube with 66 feet on an edge. China is the largest producer (13.1%), followed by Australia (10%) and the US (8.8%).

    Peak gold may well be upon us. Production has been falling for a decade, although it reached 94 million ounces last year worth $153 billion at today’s prices. That would rank gold 5th as a Fortune 500 company, just ahead of General Electric (GE). It is also only .38% of global public debt markets worth $40 trillion.

    That is not much when you have the entire world bidding for it, governments and individuals alike. Talk about getting a camel through the eye of a needle! We may well see the bull market end only when those two asset classes, government bonds and gold, see outstanding values reach parity, implying a major increase in gold prices from here. That is well above my own personal target of the old inflation adjusted high of $2,300. No wonder buying is spilling out into the other precious metals, silver (SLV), platinum (PPLT), and palladium (PALL).

    The thumbnail technical view here is that we have broken the 200 day moving average at $1,649, so we may have a clear shot at a new high. There may be an easy $100 here for the nimble, and more if we break that. The current global mood for more quantitative easing and lower interest rates certainly help. If you had any doubts for the need for such easing, taking a look at the chart below showing global Purchasing Manager Index’s heading in a clear southerly direction.

    Not that it needs it, but gold is about to get some free advertising at this week’s Republican national convention in Tampa, Florida. The right wing of the party has long advocated a return to the gold standard, and a Romney win could take us closer to that goal. I don’t think there is a chance in hell of this every happening, as it would be hugely deflationary. Still a vocal and very public discussion of the topic can’t be bad for gold prices.

    When playing in the gold space, I always prefer to buy the futures or the (GLD), the world’s second largest ETF by market cap, either outright or through a longer dated call spread. The dealing costs are far too high for trading physical bars and coins, and can run as high as 30% for a round trip.

    Having spent 40 years following mining companies, I can tell you that there are just way too many things that can go wrong with them for me to risk capital. They can get nationalized, suffer from incompetent management, hedge out their gold risk, get hit with strikes or floods, or get tarred by poor equity market sentiment. They also must endure the highest inflation rate of any industry, around 15%-20% a year, which hurts the bottom line.

    Better just to stick with the sparkly stuff.

    The Mad Hedge Fund Trader

  • Report this Comment On August 31, 2012, at 2:15 PM, MiserblOF wrote:

    Someone ask Jim when my TRX is going to start exploding. I'm planning on purchasing a gold plated harley-davidson when it makes me rich, lol.

  • Report this Comment On September 05, 2012, at 1:49 PM, Jellywig wrote:

    Mad hedge, thanks for sharing your insights. Really helpful to a newbie investor who treads with some trepidation. ..And Chris, thanks so much for the PPP recommendation (as well as all of you're good work). I'm up over 60% and think I'll hang on until the rest of the year. Any thoughts about that?

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