Express 2008-06

December 17, 2008

KBFO Gold Indices confirm sectoral uptrend

During the summer we embarked on a major program to develop an index system which would allow us to track market trends based on certain themes such as major, intermediate and junior gold producers. These indices not only allow us to track how well a particular group of companies is doing compared to broader trend indicators such as metal prices and stock exchange indices, but also how a member of an index is doing relative to that index. A full list of available KBFO Indices is available at our KBFO Indices page, which is also accessible through the "Trends" drop down menu at the top of every KBFO web page.

The KBFO Indices I wish to bring to everybody's immediate attention are the six principal gold sector indices we have created. While just about everything has been in a downtrend since late June 2008, the price of gold stopped falling in late October, and, after trading sideways through much of November, has developed an uptrend in recent weeks which has sufficient contextual support to supply the momentum needed to breach the critical $1,000 per oz barrier. We have broken down the universe of gold companies into producer and non-producer groups, which in turn have been sub-divided into major, intermediate and junior groups. The statistics and charts below clearly show that we have a gold bull market on our hands, not just in the price of bullion, but in gold companies.

The table above shows that gold bottomed at $712.50 per oz on Friday October 24, 2008 and our producer indices all bottomed on Monday October 27, 2008. Our non-producer indices did not bottom until Thursday November 20, 2008 when gold was at $738, a mere 4% higher than its low on October 24. What is truly remarkable is that all three indices in each of these two distinct groups bottomed simultaneously.

In the producer group we have the Major Gold Producer Index consisting of North American exchange listed companies with more than 500,000 ounces of annual production, the Intermediate Gold Producer Index featuring companies which have achieved 100,000-500,000 ounces of annual production, and the Junior Gold Producer Index featuring companies with 25,000-100,000 ounces of annual production. We only included companies whose primary focus is gold production. The combination KBFO Gold Producer Indices chart above shows that the major and intermediate producer groups developed an uptrend at the same time that gold stopped declining. The Major and Intermediate Producer indices have gained 72% and 64% respectively as of December 16, 2008, outperforming the 18% gain gold has mustered from its bottom a day earlier. The junior producers have not yet developed a similar uptrend largely because they are of no interest to larger investors and because they need a gold price above $1,000 to develop robust cash flow and attract a retail investor audience. However, the gain of 30% does exceed the gain in the price of gold.

The Intermediate Gold Producer Index chart above is of interest in that it reveals how well the intermediate group performed from early 2002 until late 2003, following which it has been in a downtrend. The green bars reflect the daily value traded, which blossomed in 2006-2007 even though the trend remained negative. Although the recent uptrend for the Intermediate Gold Producers may look impressive on the short term one year chart, it pales against the price gains achieved six years ago; even the value traded is low compared to a couple years ago. This pattern of seeing price gains out of proportion relative to trading activity is also evident in the gold ETF chart below, which shows gold rising more sharply since late November than trading volume.

The chart below for Eldorado Gold Corp is an example of a company specific index chart which shows how Eldorado has performed relative to gold and the overall index since January 2, 2002. The green bar in the company index charts reflects the value traded by Eldorado on any day expressed as a percentage of the total value traded by all members of the Intermediate Producer Index on that day. This feature is a useful indicator of relative liquidity among index members.

In the non-producer group we have the Major Non-Producer Gold Index featuring companies which have reported net indicated and inferred resources in excess of 3 million ounces gold, the Intermediate Non-Producer Gold Index featuring companies that have reported 1-3 million ounces gold, and the Junior Non-Producer Gold Index featuring companies that have reported 500,000-1,000,000 net gold ounces. We have only included companies where the gold component represents more than 50% of the gross metal value of the company's overall resources. This would exclude most copper-gold porphyry deposits as well as companies with silver as the dominant metal. "Net" reflects the number of ounces net to the company based on its interest in a deposit.

The non-producer gold indices have been slow to develop an uptrend because capital for development of these deposits has been unavailable, and the prospect of higher gold prices has been dampened by concern that a deflationary economic spiral would have a negative effect on gold prices. The December 16 decision by the US Federal Reserve to drop the federal funds rate to 0-0.25% is shifting the perception from deflation risk back to inflation risk as the market concludes that while the economic bottom has not yet been plumbed, this will occur some time in 2009, beyond which inflationary pressure will be evident. The flight to the perceived safety of the US dollar appears to be over, though the dubious wisdom of shifting capital into alternative currencies such as the yen and euro is sufficiently understood that this time around enough capital may move into gold to allow it to break out of a mere inverse relationship to the US dollar exchange rate so that gold increases nominally in all currencies.

Larger companies are now moving to acquire non-producers such as Orezone Resources Inc (OZN-T:$0.55) which were trapped in a funding limbo, which is triggering speculation that other major and intermediate non-producers will jump in price. The range of 15%-25% gains for the non-producer indices is slightly above gold's corresponding gain of 14% to $838.25 as of December 16, 2008.

There has been considerable hype about the supposed dollars per ounce being paid by acquiring companies. We avoid such comparisons because resource estimates do not reflect the quality of the ounces, which is defined by deposit specific parameters such as grade, metallurgy, and appropriate mining scenario, as well as location linked parameters such as infrastructure, permitting and geopolitical risk. Each deposit is unique, and what another company is willing to pay will depend not just on economic considerations, but also strategic considerations the acquiring company is unlikely to broadcast. However, everybody loves an uptrend, and, in the case of gold, whose supply-demand dynamics is not driven by economic activity, a substantially higher gold price, whose increase significantly exceeds any corresponding inflationary rise in capital and operating costs, will float all boats higher.

Although the stronger gold producers are already up 50%-100%, we expect further substantial gains if gold does breach $1,000 and establishes a new trading range of $1,000-$1,500 per oz. This would allow gold traders to profit from trading the swings in the price of gold, but it would not offer significant further upside to speculators through gold ownership. That higher upside would lie with the gold companies, which lagged the gradual uptrend in the price of gold since 2002 largely because operating and capital costs increased significantly during this period. But now we have a situation where at least temporarily operating and capital costs will be seen as stable or even declining at the same time we have a substantial increase in the price of gold. The leverage for value creation thus lies with companies which are able to acquire ounces cheaply and put them into production quickly. We are witnessing the long-awaited eruption and escalation of a bull market in gold stocks.

There is not time to produce formal recommendations, in part because our priority is to publish a new inventory of bottom-fish recommendations, and because we do not like to publish trading advice, but based on our assessment that a breakout is underway, and on our analysis of the gold indices and its members, we would like to offer the following short term trading suggestions for each of the producer KBFO Indices: IAMGOLD Corp (IMG-T: $6.70) for the Major Producer Gold Index, Jaguar Mining Inc (JAG-T: $4.05) from the Intermediate Producer Index, and Wesdome Gold Mines Ltd (WDO-T: $0.89) from the Junior Producer Index. We expect these companies to outperform their peer groups as the gold boom accelerates. Most importantly, we wish to remind everybody that a key part of a KBFO Membership is the research platform we provide. We urge that everybody check out the index system and use it to draw their own conclusions or generate fresh ideas on an ongoing basis.

We have made it easy to survey each index and its members. Each KBFO Index has its own page which includes long and short term charts of the featured index plus a number of charts we have deemed relevant to that index. This is followed by a section for each index member company that includes a company synopsis, a stock chart, an index chart which includes a normalized index for the company itself, and buttons to access other resources such as the company's KBFO profile, a People Tree, the company's web site, the Stockhouse forum, SEDAR and a current stock quote. The snapshot below is an example of an index member section. We use these KBFO Index pages as a tool to monitor a company's relative performance, and drill down to conduct deeper research when the index or stock chart action tweaks our interest. We urge KBFO members to do the same.

For those interested in the methodology underlying KBFO Indices, read on. When we decide to create an index we first decide on eligibility criteria, and then evaluate all possible candidates. The starting date of an index will depend on when we have enough eligible members. Once we have determined that a company is eligible for inclusion in a KBFO Index we assign a value of $1,000 to the company, which is converted to a number of shares by dividing $1,000 by the closing stock price on the inclusion date. This quantity of shares remains constant during the life of the index, though it will be adjusted to reflect a split or consolidation. If a company is divided into separate entities, the surviving entity that meets the index criteria has its quantity recalculated by dividing the prior day value by the subsequent closing price of the surviving entity. If a company is delisted pursuant to a takeover bid or merger, the value on the delisting day remains part of the index and the total members will include that company. The same applies to companies which have lost their eligibility. The value of the index is the total value divided by the number of members, which will be 1000 at the official start date. The value of the TSXV Index on the official start date is normalized to 1000, and the resulting factor is used to adjust the TSXV Index for comparison purposes. The same is done for any other indicator such as the price of gold.

Conclusion: The Index System represents a major stage in the evolution of Kaiser Bottom-Fish Online as a research platform for the resource sector. At the moment we have a bottom-fishing window of a sort I have never seen before, and which I may never see again once it closes over the next year or so. We have a bullish long term outlook for the commodity sector and remain optimistic that sub-sectors will flourish in the interim. The Index System is our tool for isolating and tracking trends in the pricing of resource companies, a tool which will be relevant to KBFO Members long after the bottom-fishing window has closed. The rational speculation model I developed continues to be a key tool in evaluating juniors with projects in the earlier stages of the exploration cycle; however, the IPV charts provide only a time bound comparison of relative value. Our ability to create specialized indices gives us the means to track relative value over time. It is nigh impossible to predict who will set a trend, but it is possible to identify who fits into a trend, is lagging, and does not deserve to lag. Such companies will be the focus of Spec Value Hunter picks. Over the next few months we will flesh out the synopses for each index member, making it easier to grasp what makes a company tick. Much more detailed information about company projects and their ounces or pounds in the ground is already a click away behind the KBFO Profile icon. The presentation layer of our KBFO Index pages is a work in progress. We welcome suggestions in this regard, as well as ideas for specialized indices.

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