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Thursday, September 5, 2013 - 13:00
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Monday, October 7, 2013 - 06:05
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Thursday, September 5, 2013 - 13:00

This Cheap Gold Fund Could Gain 50%

Thursday, September 5, 2013 - 1:00pm

Gold is on the rise. The commodity has seen a dramatic surge over the past two months since hitting bottom in late June.

Investing in the metal itself or in a fund like SPDR Gold Trust Shares (NYSE: GLD) are both great ways to play this trend.

But considering the historic lows that we've seen in gold producers, even bigger gains could be made by investing in gold miners.

One of the easiest ways to do this is through the Market Vectors Gold Miners ETF (NYSE: GDX).

Right now, GDX is the cheapest it's been since 2008.

David Einhorn, the billionaire fund manager, is one of the biggest GDX shareholders. His hedge fund Greenlight Capital currently owns 8.8 million shares, making him the fund's fifth-largest institutional shareholder.

In November 2011, this is what Einhorn had to say about gold miners:

"With gold at today's price, the mining companies have the potential to generate double-digit cash flow returns and offer attractive risk-adjusted returns even if gold does not advance further."

At the time, GDX was trading at nearly $60 a share and the price of gold was between $1,700 and $1,800 per ounce. Today GDX is trading around $28, and the price of gold is nearly $1,400 per ounce.

These numbers point out the huge disconnect we've seen between the price of gold and the mining companies that produce it.

The five largest holdings in the GDX fund make up 45% of the total portfolio. They are Goldcorp (NYSE: GG), Barrick Gold (NYSE: ABX), Newmont Mining (NYSE: NEM), Silver Wheaton (NYSE: SLW), and Randgold Resources (Nasdaq: GOLD).

My estimate of a 50% gain is based on a return to $45 share prices from today's price near $30. This is still well below the 52-week high of $55.

In the meantime, GDX offers a yield of 2%, and its annual expense ratio is a reasonable 0.5%.

Risks to Consider: In the past, some gold miners have allocated their capital poorly, spending too much on acquisitions when gold prices are high. Also, should gold prices decline dramatically, miners could suffer a permanent loss of capital.

Action to Take --> An exchange-traded fund like GDX is a conservative way to play gold miners -- an inherently risky sector. Although this investment is certainly more speculative, today's low prices have ironed out some of the risk. Set a tight stop-loss at the recent low of $24 with a target of $45 per share.

P.S. -- Finding major disconnects in the commodities market is something StreetAuthority's commodities expert Dave Forest does very well. He is a trained geologist with years of experience working with his "boots on the ground" at mining sites all over the world. To learn more about how you can have this world-class expert work for you, click here. 

Chad Tracy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.