Gold Miners Breakout

Gold rose briefly above $800 an ounce in Asian trading on Thursday following Ben Bernanke's decision to cut official interest rates by 25 basis points to 4.50 percent. Put more accurately, the dollar fell against gold as investors bailed out of the greenback and purchased real assets. Oil prices also rallied on the news.

"The risk is that the US economy goes into a deflationary spiral and that is something the Fed will avoid at all costs. "

The actions of the Fed clarify its intentions - sacrifice the dollar to prop up the economy. The only problem with that is, while lower interest rates will surely send the dollar lower, they will not necessarily revive the economy. Quite simply, the US economy needs a recession to purge the bad lending decisions made during the housing bubble.

But, allowing a recession in an economy that is hugely indebted (at nearly all levels) is a highly risky strategy. The risk is that the US economy goes into a deflationary spiral and that is something the Fed will avoid at all costs.

So with the fallout from the housing market still causing headaches on Wall Street and Main Street, we anticipate further interest rate cuts in the months ahead, and very likely well into 2008. Despite the Fed's 'concern' over inflation, we think that in the shorter term these concerns will be over-ruled by a rapidly slowing economy.

The best way to protect wealth in such an environment is to buy gold. The Gold Miners ETF (GDX: AMEX) provides diversified exposure to a basket of global gold miners from the largest producers down to explorers. The Fund, established last May, seeks to replicate the performance (before fees and expenses) of the Amex Gold Miners Index.

As a passive Fund, the stock picking credentials of the Manager are not really an area for concern. Being an index tracker, costs are relevant though, and GDX meets the mark on that front, with a low expense ratio of just 0.55 percent.

We initially recommended the fund at $37.20 in January (FAT49) and while performance was slow in the early stages, GDX has surged in the past few months.

The most recent development on the charts has been the break above a prolonged consolidation range. As evident on the daily chart, GDX traded between a range of $43.32 and $31.82 for 18 months, before rallying higher in September. This week, the fund set a new all time high of $50.81.

As mentioned, GDX tracks the AMEX Gold Miners Index, and given the greater trading history, we have used this index for our longer-term outlook. As seen on the weekly chart, the latest gains have extended the longer-term upward trend, which has been in place since late 2000. While we cannot rule out a near term pause for consolidation, given the resilience of the trend, we anticipate additional gains in the months ahead.

Given the pullback in equity markets on Thursday, gold stocks also suffered despite the gold price holding up relatively well. Because of this, GDX retreated by around 3.5 percent. With the fundamentals for gold increasing, we view this decline in GDX as a buying opportunity.

GDX consists of 35 gold miners and explorers, including a number of companies focussed on the production of silver. As at 31 October, the fund's top ten holdings were:

[[Security]] [[Ticker]] [[Weighting %]]

[Barrick Gold Corp.] [ABX] [14.504]

[Goldcorp Inc. ] [GG] [10.103]

[Newmont Mining Corp.] [NEM] [9.376]

[Kinross Gold Corp. ] [KGC] [5.948]

[Yamana Gold Inc. ] [AUY] [5.886]

[AngloGold Ashanti Ltd. ] [AU] [5.326]

[Gold Fields Ltd. ] [GFI] [4.811]

[Compania de Minas Buenaventura S.A.][BVN] [4.689]

[Agnico-Eagle Mines Ltd.] [AEM] [4.546]

[Meridian Gold Inc.] [MDG] [4.098]

Over the past few weeks, US, European and Japanese banks have all written down the value of mortgage related fixed income products, wiping billions of dollars in shareholder equity from their balance sheets. With many more billions at risk, these banks are relying on lower interest rates to take pressure off the size of future writedowns, which will surely come.

And despite its claim to be independent, it's not like the Fed to disappoint Wall Street. More interest rate cuts mean a weaker dollar - which is longer term bullish for gold!.

Last week, we took profits on Meridian Gold following a takeover offer from Yamana Gold, with a view to allocating the capital elsewhere in the gold sector. Following the bullish break-out from the 18 month trading range, we believe GDX represents a solid and relatively low risk destination for that capital. Therefore, we are increasing our exposure to GDX and recommend the fund as a buy to all Members around $48.80.