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Summary

  • Gold and a gold-linked ETF will provide attractive returns in the future; however, gold-mining stocks will outperform these two options.
  • Fundamentally, Newmont Mining Corporation and Allied Nevada Gold Corporation are trading at discounted prices.
  • Simple technical analysis of these two stocks can provide investors with more confidence that downside risk is minimized at these price levels.

There are many ways to gain exposure to the gold market; owning the metal itself, an ETF that holds gold and gold-mining equities are among the most common. While I do believe that the two former will provide attractive returns in the future, opportunities with greater upside potential are present in the latter. Gold-mining equities as a whole - represented by the two popular ETFs, GDX and GDXJ - have significantly underperformed gold from the peaks in 2011 to present. Gold has declined nearly 37% from its high in September 2011 (slightly below $1900/ounce) to its local low made at the end of 2013 (slightly below $1200/ounce). A similar decline - one of just over 38% - was recorded in GLD from its high to its local low in this same time period. Thus, while GLD does not exactly match the price of gold in terms of percent gains/losses, it is a very close indicator and can be used in the place of the spot gold price for comparisons. As mentioned, gold-mining stocks have underperformed gold and suffered worse high-to-local low percent losses during this time period. Fig. 1 compares these losses. One can see that gold-mining stocks as a whole still remain depressed. Due partly to this reason, I believe gold-mining stocks will outperform a rise in the price of gold.

Figure 1

(click to enlarge)

Significant price depreciation alone does not necessarily justify the conclusion that an asset is cheap. However, I do believe that starting a search in a depressed sector can be advantageous when one is looking for cheap assets. Thus, the gold-mining sector is a good place to look for cheap stocks. Research will reveal more of the picture and can allow investors to "narrow" their search and pick attractive opportunities. By looking at a variety of factors, I have found 2 gold-mining stocks that I believe possess great upside potential and should be considered if one believes that a higher gold price is imminent.

Newmont Mining Corporation (NEM)

Of the large-cap miners, I feel that Newmont is the most attractive. The company is working to cut costs and their efforts have manifested in recent earnings announcements. In the second quarter of 2014, costs applicable to sales for gold (per ounce) and copper (per pound) were reduced by 17% and 67%, respectively, compared to the same period in 2013. Gold (per ounce) costs applicable to sales outlook was further reduced by 3% to $720 from $760 in 2014. They also achieved cost savings of $359 million in gold all-in sustaining costs.

While cost cutting is important in a lower-priced gold environment, expansion cannot be forgotten and is vital for the long-term success of Newmont. The decision to develop the Merian project in Suriname is encouraging. The Board of Directors approved full funding of the mine and it is expected to begin production in late 2016, with average life of mine estimated gold production of 300,000 to 400,000 ounces per year on a 100% ownership basis. The government of Suriname has the option to purchase a 25% equity ownership in Merian.

Fundamentals

Simply put, Newmont, along with many other miners, was expensive during its run up to its high in late 2011. Some key price ratios through this time period, seen in Table 1, show this. A seemingly ever-rising gold price may be to blame, or maybe investors felt that Newmont should keep up with the high valuations also seen in its peers; either way, one must always take into consideration fundamentals that show a stock is expensive. This is much easier said than done.

Table 1

 

Average P/E

P/S

P/B

12/07

-22.94

3.99

2.93

12/08

22.37

2.99

2.53

12/09

17.67

2.99

2.13

12/10

13.33

3.22

2.24

12/11

59.88

2.92

2.3

12/12

12.29

2.35

1.66

Today, some of these ratios are significantly lower than they were 3 to 4 years ago. Two of particular interest are Newmont's P/S and P/B values of 1.73 and 1.29, respectively. Also, Newmont's low EV/EBITDA of 5.34, in general and in relation to its peers, provides more evidence that it is an attractive pick in an attractive sector. These valuations, along with my belief that a higher gold price will arise, make Newmont an attractive pick.

Simple Technical Analysis

I believe that simple technical analysis can sometimes provide more upside potential while lowering the downside risk - thus, using it to your advantage should at least be considered. Newmont's 52-week price range per share is $20.79 - $34.27. The low was set on 2/6/14 and the high was set on 8/27/13. At the closing price of $27.06 on 8/12/14, it is trading around 30% off its 52-week low. A rough reverse head-and-shoulders pattern can be seen in Fig. 2 below. A break above the neckline would be bullish.

Figure 2

(click to enlarge)

I don't think it will test its low of $20.79 anytime soon. I generally like buying as close to a 52-week low and/or a technical support level as possible. I'd like to see it fall back to around $23, which would be close to 10% off its 52-week low; however, I think this is also unlikely. I do think it has a lot of running room at this price. I will be looking for a break above the neck line and in the event of this, a test of and hold above that neckline.

Allied Nevada Gold Corporation (ANV)

Allied Nevada is a favorite of mine. At the price of around $3 per share, I believe the risk profile is very favorable. A higher gold price, a buyout, or both will allow for an appreciation in the undervalued share price of this gold miner.

Fundamentals

Just by looking at some basic fundamentals, Allied Nevada seems very cheap. As of 8/12/14, it is trading at less than half its book value of $7.53 per share, has a P/S of 1.01 and an EV/EBITDA of 11.78. Also, Fig. 3 below adds to the evidence that Allied Nevada is currently trading at a significant discount.

Figure 3

(click to enlarge)

This evidence begs the question of why this company is trading at such a discounted price. The stock is heavily shorted - 40% of float - as many investors are concerned about the debt levels and the lack of funding for the expansion at Allied Nevada's primary mine, Hycroft. In April 2014, a prefeasibility study was completed showing an after-tax IRR of 26.5% and net present value at a 5% discount rate of $1.7 billion. A gold selling price of $1300 per ounce and a silver selling price of $21.67 per ounce were assumed in calculating these values. The completed feasibility study should become available in the fourth quarter of 2014 and it is something that investors should put on their radar. As mentioned, the funding for this expansion (initial expansion capital of around $1.3 billion) is a concern and will most likely have to be provided via a buyout or a sale in the stake of the mine. However, after reading the transcript of the recent conference call, I am confident that they will be able to survive long enough to find a way to fund the expansion of Hycroft while keeping the best interests of the shareholders in mind.

Simple Technical Analysis

Allied Nevada's 52-week price range per share is $2.61 - $6.70. The low was set on 6/4/14 and the high was set on 3/14/14. At the closing price of $3.16 on 8/12/14, it is trading around 21% off its 52-week low; however, I believe it has a support level in the range of $2.90 - $3.00 and that this support level should be of greater interest than the 52-week low. Using the $2.90 price, it is trading around 9% off this support level. Due to this, I believe this is a very favorable entry point. The presence of this support helps to minimize the downside risk.

Disclosure: The author is long ANV. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: 2 Attractive Alternatives To Play A Higher Gold Price