On Wednesday December 5th, Gold (GLD) received a significant downgrade from Goldman Sachs, as the firm lowered both its 2013 and 2014 forecasts to $1,800/ounce and $1,750/ounce, respectively. The firm noted that they "see a number of growing downside risks and as a result, we find that the risk-reward of holding a long gold position is diminishing." That being said I still believe there is plenty of values within the sector, especially when it comes to two of the gold miners (GDX) that I feel are significantly undervalued.
Why do I feel these stocks are heavily undervalued and possess significant upside? The answer is fairly simple and that is the application of a mathematical formula better known as Graham's Number. According to Eben Esterhuizen the Graham Number is: "a figure that measures a stock's fundamental value by taking into account a company's earnings per share and book value per share. The Graham number is the upper bound of the price range that a defensive investor should pay for the stock. According to the theory, any stock price below the Graham number is considered undervalued, and thus worth investing in. It is used as a general test when trying to identify stocks that are currently selling for a good price."
The first of these companies is IAMGOLD Corp. (IAG) which currently yields 2.10% ($0.25) and has traded down 34.16% on the year. In my opinion there are two positive catalysts to consider when it comes to the company. From a value perspective, shares currently possess a P/E ratio of 10.53 and trade at a 29.42% discount to its 50 DMA and a 20.85% discount to its 200 DMA, which signifies the fact it is trading fairly inexpensively. The second thing to consider is the very nice value proposition the company presents to potential investors when Graham's Number is applied. IAG's diluted TTM earnings per share at 1.02, and a MRQ BVPS stands at 9.83, which implies a Graham Number fair value = SQRT (22.5*1.02*9.83) = $15.01. Based on the Tuesday's closing price of $10.74, this implies a potential upside of 39.75% from current levels.
IAG data by YCharts
The second of these companies is Barrick Gold Corp. (ABX) which currently yields 2.40% ($0.80) and has traded down 29.72% on the year. In my opinion there are two positive catalysts to consider when it comes to the company. From a value perspective, shares currently possess a P/E ratio of 9.96 and trade at an 8.00% discount to its 50 DMA and an 11.03% discount to its 200 DMA, which signifies the fact the stock is trading fairly inexpensively at current levels. The second thing to consider is the very nice value proposition the company presents to potential investors when Graham's Number is applied. ABX's diluted TTM earnings per share at 3.35, and a MRQ BVPS stands at 25.16, which implies a Graham Number fair value = SQRT (22.5*3.35*25.16) = $43.54. Based on Tuesday's closing price of $33.40, this implies a potential upside of 30.35% from current levels.
ABX data by YCharts
Fundamentally speaking, both companies possess an upside potential of at least 30% and I think a small to medium position should be established at current levels. Why am I not putting all my eggs in one basket, if such a great value proposition actually exists? The answer is simple, and although I think Goldman acted irrationally in their long-term downgrade of the commodity, the premise behind the downgrade wasn't too far off. In other words, although Gold has had a tremendous run up over the last 10 years, it may be safe to say that the commodity's year-over-year performance may not yield such great returns over the next 10 years.
Are there any negative catalysts to consider before establishing a position in either IAG or ABX? In my opinion there are two predominant catalysts to keep in mind. The first of these catalysts concerns EPS performance. Over the last 12 months, both IAMGOLD and Barrick Gold have missed earnings estimates by an average of 14.70% and 10.18%, respectively. If for any reason such earnings misses continue to occur through the first half of 2013, I'd look to reduce my current position by at least 25%. The second of these catalysts concerns operations. In the case of Barrick Gold, all eyes are on the company's Pascua-Lama project, and if production estimates of 17 million ounces of gold and 635 million ounces of silver fall short the stock could see a significant sell-off. In the case of IAMGOLD, most of the concern lies within the company's overall production which lacked significantly during the third quarter. If production by either company doesn't pick up in the next 6-12 months, I'd reverse my stance and establish a short position in both firms.