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Is it Time to Prospect in Gold Stocks?

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Alan Brochstein investigates the divergence between gold commodity prices and gold-mining stocks

One of the star performers this year has been gold, which, even after its recent correction, is still up about 15% in 2011. The gains over longer periods of time have been even more impressive, increasing about 180% over the past five years while commodities in general, as measured by the CRB Index, have been essentially unchanged. The appeal to gold investors has been diversification as well as protection against potential inflation in the future.

While the underlying metal has been precious, to say the least, the companies that mine gold haven’t exactly posted spectacular performance lately. In fact, some of the biggest companies are actually down so far in 2011. Higher labor costs and energy prices have weighed heavily on the mining industry. Additionally, a clear investor disdain for stocks generally hasn’t helped. Over longer periods of time, I've noticed the miners tend to track the metal, so perhaps there is an opportunity here. 

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Let me first start by saying that just because a stock is listed above, does not necessarily make it a buy. You need to thoroughly investigate any potential investment! Another caveat is that most of these stocks are Canadian, though their stocks are listed in the U.S. as well. 

Looking at the list, a few observations:

  •  6 of the 11 have more cash than debt, implying strong balance sheets

  • The stocks are trading at sharp discounts to their average P/E over the past 5 years

  • Several of the stocks trade below 2X Tangible Book Value

  • Most of the stocks pay dividends

  • Earnings growth in 2012 is expected to be almost 50% typically (according to Baseline Reuters, which aggregates FirstCall data)

  • The typical stock is up 3% this year, but four have declined by 10% or more

  • The typical stock has appreciated less than 50% of the move in gold over the two years or five years

One item that caught my attention beside the relative underperformance of these stocks is a new dividend policy at Newmont Mining (NEM). They have linked dividend payouts to the realized price of gold, which makes the stock potentially interesting for dividend investors concerned about inflation.

I believe there could be a disconnect between the fundamentals and the valuations of these gold mining stocks. In an environment where gold continues to rally sharply, these stocks might lag but should continue to participate, potentially outperforming other stocks in that case. The best scenario, though, is most likely stable gold prices, which could shift some of the speculative focus away from the metal and towards the miners, which have lagged. 

Gold mining stocks certainly have some risk with sharply lower gold prices, but they might hold in better assuming lower labor and energy costs in that scenario. Given the presence of dividends, perhaps these stocks may be appropriate for conservative investors given the potential income and inflation-protection. (That may prove especially true of NEM because of its policy of aligning dividends with current gold prices.) Historically, gold miners have been viewed as highly speculative, but short-term that appears not to be the case, given these stocks' low valuations.


Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator


Disclosure:  Alan Brochstein is currently holding no positions in the securities mentioned in this post.

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