Gold Stocks (GDX) Rally, “25%-50% Upside” Ahead

Gold stocks advanced Tuesday as the Market Vectors Gold Miners ETF (GDX) climbed 1.0% to $62.57 per share.  The rally in gold stocks and the GDX was fueled by a rebound in gold futures, which surged $40.50 to $1,832.10 per ounce following yesterday’s sell-off.  Canada’s leading gold stocks composite, the S&P/TSX Global Gold Index, jumped 1.4% in concert with the GDX.

Despite today’s strength in gold stocks, the GDX remains higher by just 1.5% in 2011.  This compares quite unfavorably to the 28.9% rise in the yellow metal on a year-to-date basis.  Many gold investors have been left disappointed and frustrated with gold stocks’ underperformance, particularly among the large-cap gold equities.

In a Forbes article this week, long-time gold bull Frank Holmes discussed the outlook for gold stocks in light of these developments.  He noted that BMO Capital Markets suggested one reason for gold stocks’ underperformance is that “the rate of change in the gold price has been high over the past decade, perhaps too high for investors to gain confidence in that price as sustainable for an equity investment decision.”  As a result of its findings, BMO determined that gold stocks as a group have never been as inexpensive relative to the yellow metal as they currently are.

Holmes –CEO and Chief Investment Officer of U.S. Global Investors – also noted that RBC Capital Markets released a bullish report on gold stocks.  There, the firm contended that the industry has reached an inflection point with a “substantial wave of free cash flow” arriving in the next 1-2 years.

RBC determined that gold stocks as a group currently have margins that are at record highs, and it believes margins could be approximately $1,200 per ounce for the next 12 to 24 months – significantly north of the 10-year average of $320 per ounce.  Furthermore, RBC asserted that “if gold prices remain elevated and/or investors accept a higher long-term gold price, we could see 25-50% upside” in gold stocks.

Holmes subsequently discussed his “Five M’s” for determining in which gold stocks to invest – Market cap, Management, Money, Minerals and Mine life cycle.  While he provided details on the factors influencing the Five M’s, he did not mention specific gold stocks.

Nonetheless, due to disclosure requirements, Holmes must reveal his holdings in every company his Fund holds.  As a percentage of net assets, Holmes’ U.S. Global Investors’ World Precious Minerals Fund held the following gold stocks: