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August 29, 2006

There Are Significant Risk Factors In Owning Gold Mining Stocks
by Jan Allen

Summary

There are two indices of gold stocks: the XAU and the HUI.

The HUI's price on 8-23-2006 is $346.

An analysis of the HUI, reveals that there are a number of risk factors one should consider before investing in or owning gold stocks whether the ownership be in individual shares of stock like Goldcorp or mutual funds like Vanguard Precious Metals And Mining or the ETF GDX.

I. The Current Position Of The HUI

The current five day chart of the HUI:

The HUI has completed a 5 up wave.

Ron Rosen presents the HUI Chart showing a triangular point at $340 as of 8-11-2006: the HUI is definitely a break point -- from here it will break-up or break-down.

II. The HUI may very well exceed its 5-10-2006 high of 394, but research presents five significant risk factors associated with the ownership of gold stocks:

First:

Gold stocks have soared rapidly, they can also fall very rapidly.

The HUI is astronomically high at its current value of $346 -- it has soared like a kite having risen from a low of 35 in Nov 2000. In other words, it has expanded over 10 fold in 6 years. And it has risen 350% in just four years. This 350% rise is more than the 314% rise of Exxon Mobil which took twelve years.

This meteoric rise in gold stocks is reflected in their high alpha of 66.

Second:

The PE ratios of mining stocks is high relative to stocks in general; for example, Newmont Mining, a HUI component, had a P.E. ratio of 55 on 7-13-2006; the high PEs are a bearish factor for gold stock ownership.

In fact, a number of mining companies do not even make money as is seen in the Barchart.com Mining Sector Report; or as seen in the Yahoo Finance Gold Company Browser

For the most part, mining stocks have increased on the basis of sentiment not profit; this makes them very susceptible to a dramatic downturn.

Third:

Stocks -- all stocks, including gold mining stocks, have reached a grand super-cycle high and will fall in value. Is it really worth the risk to squeeze a few more dollars of return by owning gold mining stocks?

Fourth:

The political risk is presented in The Security And Prosperity Partnership Places One's Life Savings At Great Risk; where the author presents the possibility of the change in the nature of government. Should this happens, the HUI will fall precipitously within days, at a time when gold would soar as people seek the protection of a physical commodity.

III. Observation On The Excitability Of The HUI

It should be mentioned that today's Gold HUI Ratio of 1.8 -- $GOLD:$HUI -- is a bullish for the HUI, in that it has been below its 200 day average for three days now and that there was a low of 1.6 in late April 2006 which propelled the HUI to its 5-10-2006 high of 394. The reason for the three day excitement being the growing awareness that Iran and the US are unlikely to peacefully resolve their differences over the Iranian nuclear reactor program.

IV. The Opinions Of Others

Jack Chan writes Gold Stocks Are Breaking Down

Merv Burak relates in the article Technically Precious with Merv that the XAU Chart reveals a head and shoulder formation: "the right shoulder may be sloping a little but this is not unusual. What I find to be the most telling and the best confirmation that we have a H&S pattern is from the action of the price momentum (strength) indicator. The negative divergence at the head (marked H) and a further weakening at the right shoulder suggests that there is very little strength for any upside moves."

James Turk presents a case for physical ownership of gold as the means of wealth preservation in the article Wake-Up Call

V. Conclusion

It is interesting to note that the five year return was 400% for the HUI compared to 150% for the XAU; over the years, risk accepting investors put their money in the HUI stocks rather than the XAU stocks.

Yes, the HUI may rise briefly above 396, nevertheless it, and gold mining stocks in general have the potential to fall precipitously very soon; therefore one should consider investing in the physical commodity gold.

Investing at BullionVault.com provides a secure place where one can buy and store gold.

Jan Allen
Prospering Bear

Jan Allen is an analyst and journalist with Prospering Bear, a website providing thoughtful information on how to prosper in the coming Bear financial market
http://my.opera.com/prosperingbear/blog/.

Copyright © 2006-2007 Jan Allen

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