A Glittering Investment Gift for 2014

With holiday-shortened trading this week and next, financial markets should be relatively quiet. It is a good time to take stock of your portfolio and consider new investment opportunities for 2014. That’s what I have been busy doing over the past several weeks, researching which markets have the best potential over the next 12 months. In a recent series of Money and Markets columns, I’ve shared several investment ideas with you for the year ahead.

First, emerging market stocks look extremely undervalued compared to U.S. stocks. In fact, the last time developing markets were this cheap, in 2009, they went on to post triple-digit returns over the following two years.

Second, for investors who prefer to stick with domestic stocks, I singled out two sectors that are at the top of my list for 2014. Energy companies in the U.S. are benefiting from booming domestic oil and gas production. Yet energy sector stocks are selling at a steep discount today, which makes the sector look compelling in my view.

If you can tolerate the volatility, the profit potential in gold and silver mining stocks can be truly astonishing.

Third, when it comes to undervalued stocks and sectors, technology shares look like the best bargains among U.S. stocks.

But I have saved my best idea for last, because today I’ll brief about an investment with the best upside potential I have seen in many years: Precious metal stocks. My colleague Larry Edelson frequently comments on gold and silver. So you are probably already aware that precious metals have been in their own private bear market this year.

While the S&P 500 Index has gained 28 percent so far this year, spot gold prices slumped 28.3 percent. Silver has plunged even more, down 35.7 percent year-to-date. In fact, most commodities performed poorly this year, but the underperformance of gold and silver in particular creates the potential for a very profitable rebound rally in 2014. Larry believes gold and silver prices should bottom early next year.

If that’s the case, there’s even more upside potential in mining stocks than in precious metals for one simple reason: Gold and silver stocks provide leverage. As the price of precious metals rise, the production of mining stocks and their proven reserves become even more valuable and profitable than the rise in physical prices. For proof, just take a look at the chart below.

Click for larger version

From the 2008 low to the peak in late 2011, the price of gold rose 55 percent in just over one year. But gold in the ground, as represented by the Philadelphia Gold and Silver Index (XAU) of mining stocks, rose even more, soaring 156.8 percent over the same period.

Of course leverage can cut both ways. Gold prices have tumbled 28.3 percent so far this year, but mining stocks plunged even more, with XAU down 50.3 percent year-to-date. As a result, the gap between the value of an ounce of gold and gold mining shares is wider today than at any time in years.

Granted, a valuation gap like this between physical gold and gold stocks is not unusual — it has persisted many times in the past. But when it reaches an extreme like this, it tells me that mining stocks are unusually under-priced and therefore have the best upside potential when gold and silver prices finally do bottom and eventually rebound.

In other worlds: The cheapest way to own gold today isn’t coins, or bullion bars, or even ETFs that track physical gold — but gold and silver mining shares.

Mining stocks represent many tons of untapped gold and silver reserves still in the ground, the value of which is likely to skyrocket even more than the price of gold or silver during the next bull market in precious metals.

We’ve seen downside volatility in gold and silver miners since the 2011 peak, but now the pendulum looks poised to swing back to the upside. Also, gold and silver mining stocks as a group are extremely cheap today based on traditional valuation measures.

Click for larger version

Based on price-to-net asset value (see chart above), gold and silver mining stocks are trading close to the trough valuations reached during the depths of the 2008 financial crisis.

And based on measures including price-to-cash flow and price-to-book value ratios, the miners haven’t been this inexpensive since 2001 — when the bull market in gold was just getting started.

Remember, following the 2008 valuation low, the Philadelphia Gold and Silver Index (XAU) surged 156.8 percent higher in just over one year.

After the 2001 low, XAU soared more than 300 percent until the 2008 peak.

In my view it’s just a matter of time before gold and silver prices bottom, perhaps as soon as next month, and precious metals embark on a new bull market. Mining stocks offer you a leveraged bet on gold and silver prices, plain and simple. Obviously, this leverage can cut both ways, but mining stocks have already had a substantial correction and are historically undervalued today.

When the next bull market in precious metals arrives, gold and silver miners will play catch-up with explosive rebound potential, likely surpassing the price of gold and silver in total return.

Good investing,

Mike Burnick

P.S. For three miners that are at the top of my watch list, visit the Money and Markets Facebook page.

Mike Burnick, with 30 years of professional investment experience, is the Executive Director for The Edelson Institute, where he is the editor of Real Wealth Report, Gold Mining Millionaire, and E-Wave Trader. Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also served as Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.