For gold equity investors, it's a nice problem to have. Still, it's a problem.
With gold cresting $1,000 (U.S.) an ounce yesterday - the third time in 18 months that it has inched above the elusive, near-record level - gold mining stocks gyrated back and forth, ultimately retreating when gold failed to hold its ground above the key psychological level. (The benchmark gold contract on the New York Mercantile Exchange closed at $999.80. The S&P/TSX global gold index slipped 1.4 per cent.)
While near-record prices would hardly seem like a problem for many other beleaguered market sectors, the $1,000 milestone nevertheless represents a point of confusion for investors trying to position gold stocks in their portfolio.
Does the achievement signal the dawn of another up-leg, or a stubborn peak for the rally?
The divergence of opinion is startling. Yesterday, James DiGeorgia, publisher of the Gold & Energy Advisor newsletter, suggested gold could reach $2,500 an ounce in the next 18 months and $5,000 within five years.
Meanwhile, others, such as Jack Ablin at Harris Private Bank and Julian Jessop at Capital Economics, argued that gold's rally has been driven by currency speculation - with Mr. Jessop suggesting that bullion could retreat to $850 "very quickly" once the U.S. dollar stabilizes.
The question of gold's direction has become more significant over the past year as gold-related assets have become an important staple in many portfolios seeking risk protection from volatile markets, uncertain economies and potentially inflationary government policies.
High gold prices are, unquestionably, bullish for all gold mining stocks, although evidence suggests that the current high price has largely been priced into gold equities over the past year.
Still, some gold companies are more sensitive to the price movements than others - a fact that gives some stocks a greater upside when prices are booming, and others more stability when prices fall.
In a research report issued last week, BMO Nesbitt Burns analysts David Haughton, Andrew Breichmanas and Bart Melek laid out three scenarios for gold prices. The most likely, in their view, is that gold will drift sideways in the $950-$975 area through 2011. But they also considered a bullish scenario in which prices surge to $1,300 by 2011, and a bearish scenario in which prices retreat to $750-$800 over the next two years.
For each scenario, they identified the gold stocks that stand to deliver the best performance - based largely on the sensitivity of each stock's net present value to bullion price changes.
"In general, emerging producers offer the greatest upside potential, as well as the most downside risk," the BMO analysts wrote.
THE BULL CASE
Top picks:Silver Wheaton Corp., Minefinders Corp., Eldorado Gold Corp., Harmony Gold Mining Co. Ltd.
BMO's favoured stocks in its bullish gold price scenario generally offer considerably more upside potential in their net present values (NPV) should gold prices surge than their downside risk should the market turn sour.
Minefinders, for example, could see a 73-per-cent growth in its NPV if BMO's bullish-case price projection proves accurate, while the downside risk to its NPV in the bear case is only 48 per cent.
THE BEAR CASE
Top picks:Franco-Nevada Corp., Alamos Gold Inc., Newcrest Mining Ltd., Centamin Egypt Ltd.
The bear-case picks are typically defensive - companies with minimal exposure to falling prices, even if their upsides should prices rise are limited. Franco-Nevada tops this list, with only about a 10-per-cent downside in its net asset value at bear-case prices.
THE BASE CASE
Top picks:Red Back Mining Inc., Newmont Mining Corp., Centerra Gold Inc., Golden Star Resources Ltd.
All things being equal, the BMO analysts favour stocks trading at relatively low multiples to their NPV, as well as ones with generally better upside potential than downside risk. For example, Newmont, one of the biggest stocks in the sector, is considered relatively low risk because "the scale and scope of their operations dilute operational and political concerns," the analysts said.