The economic uncertainty surrounding Europe, the United States, and most of the world has provided a landscape where investors are extremely bearish and fearful of the prospects of another potential recession. This has led investors to pour billions into treasury instruments and other “safe-haven” investments such as commodities. Gold and silver prices, in particular, have ridden this wave to all-time highs. This article will discuss gold and large gold-mining companies.
Investors and speculators have poured their money into futures contracts, bullion, coins, and increasingly-popular ETF funds. The SPDR Gold Trust (GLD) now holds approximately 40 million troy ounces of gold bullion, which would place the fund as the sixth largest supply behind the governments of the United States and Germany, the International Monetary Fund, Italy, and France, as documented by SPDR Gold Shares and the World Gold Council. With such a large injection of momentum and investment into the gold ETF, it would make sense that the mining companies producing gold would see a similar or greater increase in their stock price as their bottom-line often improves at a greater percentage than the rising spot and futures prices of gold, producing a “leveraged” effect on the earnings. The market has not extended these gains to the gold producers though as the mining stocks have for the most part missed the bubble developing in gold, but the companies themselves will still benefit directly from rising gold prices.
The chart below illustrates the year-to-date performance of GLD against some of the largest gold-mining companies. I have also included the PE and Forward PE ratios of these stocks for comparison.
(Click chart to enlarge)
All of the stocks listed above are projected to have a large jump in earnings compared with income of the previous four quarters. This is illustrated by the large drop in Forward PE across the entire industry with Barrick Gold (ABX), Newmont Mining (NEM), Kinross Gold (KGC), AngloGold Ashanti (AU), Yamana Gold (AUY), and Compania de Minas Buenaventura (BVN) all having Forward PE Ratios of under 15. The increase in the market price for gold allows for possible mine expansions or re-opening of shuttered mines as locations with higher extraction costs suddenly become profitable. According to the June 2011 ABN AMRO Gold Mine Cost Report, a survey of the production costs of 111 gold companies, the average extraction price per ounce of gold increased 13% to $620 for Q1 2011. This compares very favorably with an average gold price during the same period of $1,387. The price of gold has since increased almost $400, allowing for even greater margin increases. Companies with mining operations in North and South America are enjoying the largest differences between the extraction costs and the average gold price.
Once the market volatility declines and the debt issues become more clear, more investors will likely move back into equities. By identifying opportunities that are undervalued now, you can outmaneuver the crowd and position yourself for the intermediate term. The longer the bubble in gold lasts, the greater the earnings that gold stocks will bring in as the gap between gold extraction costs and gold prices continues to increase, making it harder and harder for investors to overlook.