Why junior exploration companies and small gold stocks offer best value

Gold investors are happy with a 25 per cent gain in the price of the yellow metal in the first half of 2006, even if there has just been a thumping correction.

Many see this as a buying opportunity in a bull market that will resume after gold has coasted through the summer. Indeed looking at the pattern of every year of this gold bull market since 2000, and the best performance is always reserved for the second half of the year.

Given the huge first-half rally that took gold to $725 before it fell back, to $613 at the time of writing this article, then there is reason enough to expect whatever happens in the gold market this autumn to be spectacular, or at least on a bigger scale than in recent years. Moreover, Friday's $27 rally in the gold price was the best for five years.

So if you accept the bull case for gold, how do you position for maximum advantage? Professionals like the new Exchange Traded Funds. They are convenient being paper advanced against physical holdings of gold, and can be held and traded instantly like common shares.

ETF gains

But anything related to gold bullion itself, like the ETFs, is not leveraged in any sense, and in order to produce maximum gains in a bull market you need an investment vehicle that magnifies the gold price effect.

Last December AME Info published an article reviewing the outlook for junior exploration and smaller gold stocks, and it is worth reviewing how these stocks have performed in the first half of 2006. There are many stock picking newsletters available, and we highlighted a selection from James Saks, a Canadian researcher.

These six stocks are up an average of 52 per cent in the first half of 2006, or more than twice as much as the gold price. Individually three shares rose by more than 100 per cent - Glencairn Gold, Avino Gold & Silver and Linux Gold, although Linux Gold fell back to close 33 per cent up; while Skyharbour Resources was up 50%, Teryl Resources closed three per cent higher and Nova Gold was down four per cent, after being up almost 50 per cent at one stage and is still heavily tipped by newsletters.

For comparison with the performance of bigger gold stocks the American Gold Bugs Index - which includes big gold mining companies with little hedging to the gold price - is a useful benchmark. The HUI index was up by 31 per cent in the first half.

Juniors perform best

Therefore even after a wildly volatile first half of 2006 the conclusion for gold investors ought to be that the best way to play this bull gold market is by buying the junior exploration companies and smaller gold stocks.

This makes sense empirically. Junior exploration companies are the ones that can deliver really big profits to their shareholders if they strike gold, and they also own mining concessions in areas likely to produce the metal. Owning the rights to a plot of land that might contain gold is something that will rise exponentially with a surging gold price, judging from previous gold bull markets.

The difficulty is to know which smaller gold company to buy. The leading newsletters like The Granville Newsletter, Casey Research or Gold Forecaster all offer lists narrowed down by experts; and perhaps the best option is to buy a basket of smaller companies based on recommendations like these. The downside will be increased volatility to your investment, but the returns should be significantly higher.