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Buy This Unloved Sector For A Golden 2013

Wednesday - 1/16/2013, 1:48pm  ET

Every year brings with it a few innovative, fresh investment opportunities.

When trying to figure out the best bargains for the upcoming year, most investors try and ride the 'stars' of the previous year. In almost all cases, last year's winners are this year's losers, and vice versa. In order to avoid this error in judgement, it is best to take a very close look at last year's laggards -- at the sectors that underperformed, and are therefore greatly hated and abandoned by the general market.

The sector that I believe will shine brightly in the year 2013 is the hated gold mining industry.

Why this sector will outperform in 2013

I believe the gold mining sector will outperform any other investment sector in the year 2013 for three reasons:

1. The sector is dirt cheap

When the big names in gold mining are trading at single-digit multiples, it's time to start paying attention. And these are not just junior, high risk miners. Right now, globally renowned companies such as Barrick Gold , Newmont Mining  and Kinross Gold are currently trading at forward P/E multiples of 6.9, 9.3 and 8.9, respectively. Compare these P/E multiples to the 16 P/E of an average company on the SPDR S&P 500 , and you get yourself a bargain. There is a potential 50% increase from here just to get in line with prevailing market valuations.

2. They're paying dividends

In the past, gold mining companies never paid a dime in dividends. Not paying dividends has been deeply embedded in the corporate culture of gold miners. But all of that has changed in the course of the strong bull market in price of gold. In fact, total dividend payments for the top 20 gold mining companies, according to market capitalization, are up 44% from 2010. Newmont Mining, for example, made waves by announcing it would link dividends to gold’s performance.

Basically, now there is a hidden stash of cash on the balance sheets of many of the gold companies. After years of not paying a dime in dividends while harvesting gold at skyrocketing prices, there is plenty of room for dividend hikes.

Reason #3: Arbitrage

There is a strong correlation between the price of gold, the metal, and the performance of shares of gold companies. When the former rises, it only makes sense that the latter will follow. After all, a higher gold price translates almost immediately to greater profits for gold companies.

But Mr. Market does not always act rationally. Every once in a while, a gap opens between the price of the metal and shares of gold companies. This gap normally closes within a few months. Take a look at the graph below: the Market Vectors Gold Miners is in blue, the SPDR Gold Shares  is in green, and the SPDR S&P 500  is in red.

As of now, gold miners are underperforming the metal and the S&P 500 by 20% and 30%, respectively. That is a huge discrepancy in prices, which is bound to close. When such a similar arbitrage opportunity occurred in May and August 2012, miners have surged by 15% in the following month alone.

The fool looks ahead

The gold mining sector as a whole is currently hated, cheap, and has a great arbitrage setup for a surge in prices. Once you count in the potential for substantial dividend distributions, I believe investors are now looking at a golden opportunity heading into 2013.  

This article was originally published as Buy This Unloved Sector For A Golden 2013on Fool.com

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