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Gold Ends Week Weak but Juniors are Simply Cheap

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Gold was not able to hold onto the $1600 level this week, closing out COMEX trading at $1595 per ounce.  Not even weak U.S. GDP and unemployment data released this morning was enough to lift Gold coming into the end of the quarter.  However, after a brutal 5 month sell off that brought it back to test the $1550 level, Gold put in the first positive monthly close since August of last year.

While not a reversal signal by any stretch of the definition, tracing an inside bar for the month of March does send a strong signal that selling volume is lightening.  With mining and exploration stocks trading at historically low valuations relative to the underlying commodity investors should begin looking to rotate out of over-priced broad equities and into the unloved ones.

Right now, Gold is trading at a ratio of more than 96:1 to the Market Vectors Junior Miners ETF (AMEX:GDJX).  The HUI and XAU are in similar positions, but with good reason as many of the major miners have been understating their extraction costs and their lack of earnings have helped place a real drag on the price of gold.

It, of course, makes no sense that the HUI should have any effect on the price of gold since gold’s price is determined by its demand as a monetary asset but sometimes there is no logic in the minds of hedge fund managers who have been playing this game for more than three years now.

I would begin looking very seriously at well-run, mid-level producers with good management and properties as well as junior explorers with excellent properties and a sound geological game plan.  For these reasons I like Yamana Gold (NYSE:AUY) a lot.  If I have a complaint about Yamana it is that its dividend payout ratio is too low.

Now, we know why the dividend ratio in the mining sector has been low for years – higher extraction costs and lower grades than were sold to investors – but Yamana is producing well and executing even better.  Operating margins are solid and rose all through a difficult 2012 but production is set to rise 33% over the next three years and my belief is that gold is now sorting out its new bottom between $1525 and $1600 per ounce.  The 1.7% yield is not enough to attract investors in this market where the S&P 500 (NYSEMKT:SPY) makes new highs every week.

As for explorers, with the situation in the majors playing out as it has where Barrick (NYSE:ABX) and Newmont (NYSE:NEM) had to sacrifice their leadership over poor project valuations, companies like Valor Gold (OTCBB:VGLD) stand to benefit nicely if they find gold.  With properties situated in the heart of northern Nevada’s gold belt Valor has the potential to be the big win to replenish reserves that these wounded giants need.

Its Red Rock property lies nearly equidistant between four currently operating and producing mines, two of which are operated by Newmont and two by Barrick.   These two firms, in particular, will be sorely tempted in the event of a discovery putting Valor in a great position to see maximal valuation in the case of a buyout.  While some explorers get into the game to mine the metal themselves, this company has no comparative advantage in assuming that risk.

The risk of investing in Gold – and especially gold miners — right now after everything that has happened in Cyprus is minimal.

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