Dear Reader,

There’s a certain pattern to many business news stories. Articles appear, praising some sort of innovative management practice from a new, successful company. For example, the firm may offer an excessive amount of vacation time, two-hour lunch breaks, and a dress code of flip-flops and t-shirts.

Sometimes the benefits are simply greater pecuniary rewards. The average salary will exceed the industry, the medical benefits will be outstanding, the retirement plan will draw envy, etc. Then these articles explain how these revolutionary two-hour lunch breaks and flip-flops lead to a more relaxed and productive work environment. The CEOs will point their fingers at the rigid organizations within other firms. Those other companies, of course, “just don’t get it.” On top of this, the trailblazer will take pride in its quirkiness and weirdness.

There are a few problems with this approach, from the perspective of economic theory. The marketplace is pretty efficient over time. Sure, innovations can take time to transfer across industries, but eventually it happens. Consider something like the self-checkout at the grocery store. A few years ago, I could only find a single grocery store in town with the system. Over time, more and more stores adopted it. Now I can’t find a single grocery without the self-checkout lane.

The change wasn’t immediate. After all, there was plenty to be skeptical about. Grocery store margins are thin and even a few stolen products hurt. Nonetheless, almost everyone has adopted the revolutionary system.

But this same transformation almost never happens with these “innovative” companies. One hears about the two-hour lunch break in some new startup, but the idea never seems to spread. Trust me – if companies can find some way to make more money, they’ll do it. Businesses can be close-minded, but in the long run no one is close-minded about making a buck.

So what’s going on? Economic theory helps explain that as well. For a long time, economists have recognized that strange business practices can exist in protected industries like monopolies and oligopolies. Think about unions with labor practices unmatched at other jobs. Where are unions most prevalent? In workplaces insulated from competition, usually with the aid of government monopoly. For example, government agencies are insulated from profit and loss. Hence, they can pay excellent healthcare benefits and above-average salaries.

Another heavily unionized sector is utilities. Oftentimes, one power company will hold a government-granted monopoly over a city, and as a result, the company can afford expensive, unionized workers. The same goes for industries with other forms of protection, such as tariffs and bailouts. In this case, the steel and auto industry are good historical examples.

In these industries, we see practices that aren’t present almost anywhere else. Market power affords these companies their frills. In a way, it’s the exact opposite of the conclusion most business management articles reach. It’s not the two-hour lunch break that makes the company successful: Rather, it’s the company’s success that affords its employee such a nice break.

How do labor unions and monopolies tie in with tech companies and startups? Often, the really big stars will either hold technology patents or will be way ahead of the crowd. Essentially, the patents grant them a monopoly over a product – as well as the luxuries that come with monopoly. The same is true of many other new companies – Groupon and Facebook, for example. They don’t need patent protection to be successful, but the two companies have a considerable head start on the competition. With some market power, they can have a quirky CEO, or a fleet of inexperienced 20-year-olds working for them. It’s no big deal. They’re ahead of the game.

However, look at more competitive industries – the standards will be much stricter. One can’t take a two-hour lunch break when neck-and-neck competitors are swallowing their meals at their desks. Despite these observations, business magazines keep dishing out the same old story of a successful company and a strange business practice. But they miss the most basic lesson of all: Correlation doesn’t mean causation.

In today’s issue, Jeff Clark will discuss the gathering bullish consensus on gold stocks among big-time institutional players. Then I’ll share some good old communist jokes for the Friday Funnies.

The Gold Stock Undercurrent

By Jeff Clark, BIG GOLD

Monitoring the gold industry requires a lot of reading, scanning websites, some more reading, calling, emailing, and still more reading. And all that perusing has alerted me to a theme emanating from the analysts in our industry about gold stocks – one that may not be well-known to outside investors.

That theme is this: Gold stocks are seriously undervalued. That may seem obvious to some; but it’s the widespread consensus I’ve picked up on that’s quite remarkable. And if word of this were to spread outside our sector, we could start to see a groundswell in the precious metals equities.

The following statements have been made within the past couple of weeks. Keep in mind that this is what these institutional, hedge, and mutual fund managers are telling their clients. Take a look:

Tocqueville Gold Fund Portfolio Manager John Hathaway: “I’m looking for gold stocks in general to be re-priced over the next several months. Gold stocks have tremendous catch-up potential. I don’t know whether that’s 30% or 25% or 40%, but it’s something like that because of what kind of earnings they’ll report… Mining stocks will be producing great earnings, while the rest of the economy is stalling out. Just by exception, people will have to look at them. That to me will be very positive for mining stocks I think for the next 6 to 12 months.”

Raymond James/Canada: “With many of the equities trading at historically lower multiples, we would view this as an attractive buying opportunity… We recommend investors take advantage of the strengthening precious metal prices by accumulating gold and silver equities ahead of the typical fall rally.”

BofA/Merrill Lynch analysts said precious metal stocks are “substantially undervalued… Based on the higher gold and silver price forecasts (offset somewhat by the lower copper prices) we have increased our price objectives on most of our stocks under coverage. Our analysis indicates that gold stocks are reflecting a gold price in the $1,200-$1,300/oz range.”

Dundee Capital Markets updated a study of the historical price-to-net-asset-value multiples on a number of gold equities and described the situation as one of “bargain basement prices.” Their conclusion: “Our analysis suggests that most of the gold producing companies appear undervalued and therefore offer excellent investment opportunities at this time. In fact, we recommend an overweight position in gold equities as the summer wanes and we head into the fall season, traditionally a great time to own gold companies.”

RBC Capital Markets noted the relative underperformance of the gold stocks, stating the stage was set for a “potential surge in gold equities.”

BlackRock’s Catherine Raw of the Gold & General Fund said regarding gold miners, “I, as an investor, would say that in the end, given that belief the world isn’t going to collapse, if you’re prepared to be patient, then I would see now as a very good buying opportunity.”

HSBC Global Asset Management, putting its money where its mouth is, reportedly sold most of its physical gold holdings and bought gold shares. “Gold equities will remain under pressure while investors remain fearful, but once investors feel that the risk of another leg down in general markets passes, or after a downswing in the markets, we feel the gold equities will do some catching up.”

Blue Phoenix CEO John Licata: “Gold companies… are not factoring in $1,500 gold prices. Many of them are still building models based on $1,000 gold. So to me there’s a lot of value still within the gold sector that has not been realized.”

Sprott Asset Management’s Chief Investment Strategist John Embry: “They [gold and silver equities] haven’t moved up a lot with gold and silver… they’ve been sort of wallowing a bit… If money decides it has to come into this space, it’s going to be like Internet stocks in the ‘90s, except the mining stocks are going to have real fundamentals.”

CIBC’s Barry Cooper said the proliferation of bullion ETFs is a “market-sentiment driven event that will pass, as fundamental financial drivers kick in to support share prices and drive them higher.”

U.S. Global Investors Chief Investment Strategist Frank Holmes: “There is a substantial opportunity to buy healthy gold mining companies at historically low prices compared to gold… With gold companies currently undervalued and offering strong cash flows and attractive yields, we think gold equities will be rewarded by the market and rise with strong gold prices.”

BMO financial analyst Don Coxe: “Gold and gold stocks offer protection that is going to become more valuable in the months ahead. It’s possible that the long-awaited period, when gold stocks outperform bullion, is coming soon.”

You might be tempted to take the contrarian view, since they’re all leaning to one side of the boat. I think that would be the wrong move. While gold stocks have moved up nicely over the past 30 days, and a short-term correction may be due, these comments are all from within the gold industry. The general public, in spite of some new bullion buyers this year, don’t have gold stocks on their radar at this point. When they are all invested, maybe then it will be time to be contrarian.

Of course, just because a stock represents good value doesn’t mean it must rise – or if it does, that it will do so soon. The point with many of these comments is that buying now – this summer – will fetch you very good value. And for the big-picture investor, that’s exactly what we’re looking for.

Remember, gold stocks have already demonstrated some serious leverage to gold in this bull market. From the 2001 bottom through the end of 2007, gold producers as a group rose about 1,200% (as measured by the Amex Gold Bugs Index), while gold was up about 230% in the same time frame. They outperformed the metal by five to one. Historically for the producers, the ratio is closer to three to one. Either way, my bet is that at some point, those days will return.

And maybe we’re nearing that time now.

[Not all gold and silver stocks have good value. Some will perform much better than others, so you want your money invested in the best of the best. We just recommended one of the hottest silver producers in the industry – a name most institutional investors are just now picking up on. Get its name and all our recommendations with a no-risk trial subscription to BIG GOLD.]

Friday Funnies

For today’s Friday Funnies, we have some good, old-fashioned communist jokes. Many older readers have probably heard some of these before, but it’s good to keep passing them on:

Three workers find themselves locked up, and they ask each other what they’re in for. The first man says, “I was always ten minutes late to work, so I was accused of sabotage.”
The second man says, “I was always ten minutes early to work, so I was accused of espionage.”
The third man says, “I always got to work on time, so I was accused of having a Western watch.”

Q: Why does the KGB operate in groups of three?
A. One can read, one can write, and one keeps an eye on the two intellectuals.

Stalin decides to go out one day and see what it’s really like for the workers, so he puts on a disguise and sneaks out of the Kremlin.
After a while he wanders into a cinema. When the film has finished, the Soviet anthem plays and a huge picture of Stalin appears on the screen. Everyone stands up and begins singing, except Stalin, who smugly remains seated.
A minute later a man behind him leans forwards and whispers in his ear: “Listen, Comrade, we all feel exactly the same way you do, but trust me, it’s a lot safer if you just stand up.”

A man saves up his rubles and is finally able to buy a car in Soviet Russia. After he pays his money the he is told he will have his car in three years.
“Three years!” Then he asks, “What month?”
“August.”
“August? What day in August?” he asks.
“The second of August,” is the reply.
“Morning or afternoon?”
“Afternoon. Why do you need to know?”
“The plumber is coming in the morning.”

A KGB officer is walking in the park and he sees and old Jewish man reading a book.
The KGB says, “What are you reading, old man?”
The old man says, “I am trying to teach myself Hebrew.”
KGB says, “Why are you trying to learn Hebrew? It takes years to get a visa for Israel. You would die before the paperwork got done.”
“I am learning Hebrew so that when I die and go to heaven I will be able to speak to Abraham and Moses. Hebrew is the language they speak in heaven,” the old man replies.
“But what if when you die you go to hell?” asks KGB.
And the old man replies, “Russian I already know.”

That’s it for today. I’m told David should be back next Friday, but I can’t know for sure. Thank you for reading and subscribing to Casey Daily Dispatch.

Vedran Vuk
Casey Daily Dispatch Editor