A 15% dip in the shares of one big gold miner could signal a buying opportunity.
This week's London Bullion Market Association (LBMA) conference saw the who's who of the gold-trading industry gather in Hong Kong for the industry's annual meeting.
When the delegates were polled at the start of the conference, their consensus forecast was for the price of gold to rise to $1,914 per ounce by September 2013.
If that forecast proves accurate, holders of shares in Gold ETFs such as the SPDR Gold Trust ETF (NYSE: GLD.US) and London-listed equivalents such as ETFS Gold Bullion Securities ETC (LSE: GBS) could make profits of 11% during the next year.
Fear drives demand
Gold ETF holdings hit an all-time high of $151 billion in the third quarter of 2012, with a record inflow of $21 billion.
What lies behind this trend is the widespread fear of inflation and currency devaluation, which is being driven by a combination of the eurozone crisis and the US Federal Reserve's unlimited quantitative easing (QE) programme.
QE has historically driven the gold price higher and it probably will this time, but there are some signs that the gold bull market has reached a more mature stage and that gains from here are likely to be more modest -- 5% or 10% per year, rather than 20% or 30%.
To illustrate the possibility of modest gains, after spending two days talking about gold, the delegates at the LBMA conference became less optimistic.
At the end of the conference, their average forecast for the price of gold next September was just $1,849 per ounce, or 3.5% lower than their opening forecast and equivalent to a more modest 7% gain for anyone buying gold at the recent $1,727 price.
All this highlights the prime risk of investing directly in commodity ETFs -- your profits depend on the price of the underlying commodity performing. The good news is that there is an alternative gold investment that could provide much bigger profit potential.
Larger gains in gold stocks?
Gold miners don't need the price of gold to rise in order to make fat profits for shareholders. Most of the major gold producers have cash costs of less than $800 per ounce, meaning that a price of $1,700/oz provides massive profit potential. If the price of gold goes higher, then that's just the icing on the cake.
FTSE 100 (UKX) star performer Randgold Resources (LSE: RRS) (NASDAQ: GOLD.US) demonstrates this profit potential better than most. Unlike many of its peers, Randgold's share price has consistently outperformed gold over the last ten years, rising by 1,400% while the price of gold gained 450%.
Randgold's reserves have tripled to nearly 30 million ounces over that period, and the company has $444 million of cash on hand as well. Randgold's pre-tax profits are expected to clock in at a record $402 million this year, as it continues to ramp up gold production.
Development of Randgold's biggest project to date -- the giant Kibali mine in the Democratic Republic of Congo -- is proceeding on schedule, and the first gold production is expected by the end of 2013.
If gold prices remain at current levels, Randgold's profits are likely to rocket when production ramps up at Kibali.
To give you an idea of what's expected, analysts' consensus forecasts suggest earnings per share of 303p this year and 463p for 2013 -- a 53% increase that places the company on a 2013 forward P/E of about 14 -- cheap for such outstanding growth.
15% drop is overdone
Randgold's share price has fallen 15% over the last month, mostly due to a mixed set of Q3 results and a round of profit-taking after its share price hit an all-time high.
However, Randgold's share price fell sharply this week when news emerged that the president of the Ivory Coast, lassane Ouattara, had unexpectedly dissolved his entire government.
Randgold's Tongon mine is located in the Ivory Coast and produced 159,955 ounces in the first nine months of this year -- about 28% of the company's total production.
The surprise dissolution spooked investors, who feared that it could be a sign of impending instability in the country, a reaction that wasn't helped by news that Randgold's chief executive, Mark Bristow, had sold £3m of his Randgold shares the day before, leaving him with a £47m stake in the company.
However, Randgold has been in similar situations before and has always rebounded strongly, something I think is likely to happen again. I believe that now could be an excellent opportunity to buy Randgold shares, ready for the next round of growth.
Spotting a winner
If you had invested £10,000 in Randgold ten years ago, you would now have a holding worth £140,000 plus dividends -- an impressive profit.
Randgold Resources is a classic mining success story and demonstrates how you can make large gains and transform your wealth by identifying promising mining companies at an early stage.
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> Roland does not own any of the shares mentioned in this article.