Avoid Paying the 'Hype Premium' for Gold: Buy Gold Mining Stocks Instead

by: Daniel Long

It has become easier than ever to own gold these days and with the poor performance of stocks and the economy in turmoil, it has become almost fashionable to admit that you are parking your cash in Gold. With the exception of a few misled folks buying gold coins and other physical forms thanks to a barrage of television commercials, most investors buy gold just like a stock using ETF's. The SPDR Gold Trust ETF (NYSEARCA:GLD) is the most popular and it tracks gold at 1/10'th the price of an ounce, and is backed up by physical 400 ounce gold bars. For those less adverse to risk, the Proshares Ultra Gold ETF (NYSEARCA:UGL) is designed to double the percentage moves of gold prices.

With gold remaining near all time highs for several years now, it seems prudent to wonder just how much of a safe haven gold really is for your cash, especially for a large chunk of it. How much of a hype premium are you paying for something that used to be more boring than Government Bonds. A better way to play the gold boom right now might be to buy gold mining stocks. This way you can put a lot less capital at risk and still obtain somewhat of a hedge against the economy. The Market Vectors Gold Miners fund (NYSEARCA:GDX) is an ETF that mirrors the NYSE Arca Gold Miners Index.

The high price of gold over the past few years has allowed many of these companies to improve earnings and more notably, their balance sheets. This improvement has accelerated over the last year as energy expenses, which is their biggest cost of revenue, have cooled off. Gold miners as a whole do not have a P/E and their price to book value is 2.62. The more elite group of gold miners that make up the GDX ETF sports a fairly low price to earnings ratio of 21 and a very low price to book value of 1.91. Better balance sheets for this group means more cash available to increase exploration without hurting their profits.

One thing that may hurt their profits, at least in the near term, is the very recent resurrection of higher Oil prices. This may be evident in the next couple of earnings releases, however a couple of factors may help stem the losses from higher priced gas. First of all, these companies tend to use more price stable sources of energy, like electricity and natural gas. Secondly, higher oil prices coupled with the recent pullback in equities has brought some weakness back to the dollar. Although not guaranteed to continue, this has caused gold to climb right alongside of oil. Let's dig a little deeper into a few smaller Gold mining companies that have improved their balance sheets over the past couple of years and are looking to increase exploration.

Golden Star Resources (NYSEMKT:GSS), which mines for gold in West Africa and South America, has more than doubled over the past year, but still has a price to book value ratio of 2.03. Cash on the companies balance sheet has been growing while their long term debt has shrank and stabilized. In fact, they currently have $40 million more in strait cash than they do in long term debt. The company sites higher gold prices and lower electricity cost's as the major factor in their quarter over quarter earnings increases. The company has doubled it's exploration budget to 18 million for the year, and has spent 4.6 million already in the first quarter compared to 9 million for all of 2009, and 7.5 million in 2008. The stock is currently included in the GDX ETF at 0.5% of the fund's holdings.

Gammon Gold, (GRS), which operates in Mexico, makes up about 0.4% of the GDX and is currently trading at a fifty two week low. The company recently announced that their 2008 and 2009 financial statements should not be relied upon due to a mistake in their Peso conversion figures. Their most recent quarterly report, however, is not in question, and the company reported their tenth consecutive quarter of positive cash flow. They also added 100 million in cash and brought their net cash position up to 89 million. The company says it has started a 26-30 million dollar exploration program and has addressed some productivity concerns that have kept the stock down over the past couple of quarters.

Capital Gold Corporation (CGC-OLD) is not part of the GDX primarily because of it's small size, but was recently included in the Russell 3000 Index. This company also operates in Mexico, but they apparently managed to get the currency conversion right. The balance sheet for this company is not quite as beefy, but it has been improving quarter over quarter and year over year. Their cash position doubled last quarter to around 9 million, and their long term debt shrank to just 1.7 million. Earnings have driven the improvement, and their P/E of 16 is lower than even the overall Basic Materials Sector's P/E of 19. Capital Gold saw increased profits on higher gold prices and increased production, however, the deeper and faster they dig, the more diesel fuel and other resources they have been using to get the product and the waste back out. The company needs to vamp up their exploration, and at least for now, they have some cash to do it.

Disclosure: No positions