Gold (NYSE: GLD) soared past $1300 per ounce after the results of Brexit referendum, which shocked financial markets all across the globe.
Previously, I was becoming increasingly skeptical of the gold rally, as it was only supported by speculative activity while demand for gold's use in technology and jewelry was shrinking.
The thesis looked valid for some time and gold looked ready to go below the $1200 support, but first the Brexit worries and later the actual Brexit fueled a massive rally in gold. I had confidence in my thesis and I decided to sell my position in Kinross Gold (NYSE: KGC) as I feared a major correction.
Now, like other investors who were skeptical that the rally may continue without a major rebound, I am faced with a dilemma - stay on the sidelines and risk missing another major move in gold equities or get in the current levels and risk a massive correction if Brexit fails to fuel more upside in gold.
First of all, I'd like to mention that gold equities failed to show their usual leverage to gold price on Brexit day.
For example, Barrick Gold (NYSE: ABX) added 5.79%, Kinross Gold added 4.29% and Harmony Gold Mining (NYSE: HMY) was up 8.38%. I highlighted the companies of different size and cost structure to show one thing - this is not the kind of a performance you'd expect from gold stocks when gold rallies from $1260 to $1320 and goes past $1350 at one moment of the trading day. In my view, gold equities could have shown greater upside.
So, if we were supposed to buy gold equities now, where should we look? The first option is to buy big producers like Barrick Gold, Goldcorp (NYSE: GG), Newmont Mining (NYSE: NEM) or Agnico-Eagle Mines (NYSE: AEM).
What do you get? The benefits of the scale and low costs (all-in sustaining costs in the first quarter were $706 per ounce for Barrick Gold, $828 per ounce for Newmont Mining, $836 per ounce for Goldcorp and $797 per ounce for Agnico-Eagle Mines).
However, there are certain problems. Barrick Gold and Newmont Mining have added a lot of capitalization this year (especially Barrick Gold), and they will likely need more sustained upside in gold to move significantly higher.
Agnico-Eagle Mines, which is arguably one of the best-run gold miners in the world, is perpetually expensive compared to its peers. Agnico's shares have been "overpriced" compared to peers for the last years, and this premium is deserved, but, at the same time, the premium limits potential upside.
As for Goldcorp, the company has underperformed recently and will have to show investors that it is back on the right track when it reports its second-quarter results. All in all, I don't see big potential in big names. The sentiment has grown overly bullish for gold, and it takes more money to move bigger capitalization stocks. Whether this money exists is a big question.
They have been more sensitive to upside in gold due to their higher-cost structure. These stocks are all up close to 200% year-to-date. These are huge gains and one of the primary reasons why I became skeptical of my Kinross Gold position.
Among these miners, IAMGOLD provides more leverage to upside due to its higher-cost structure. However, the elevated levels of all of the abovementioned stocks make them suitable only for momentum plays. Despite Brexit, I still believe that a correction is necessary before considering a new longer-term position in these high-flying names.
In this group, Harmony and Sibanye look the most interesting to me.
Harmony had monstrous upside this year, partially due to the fact that $1050 gold presented survival risks for the company. When these risks were gone, the shares were free to fly.
South Africa is still not the best place in the world for miners as unions battle for power and routinely engage in strikes and protests, but the upside in gold outweighed these inconveniences.
In this group, I believe that Sibanye Gold may have decent potential in case of additional upside in gold prices. Contrary to peers, Sibanye Gold corrected from highs and does not look extremely overbought.
Royalty and streaming
The royalty and streaming model has been very successful during the precious metals downturn, and the downside was relatively limited for these companies.
However, the scarcity of these companies lead to another problem - they are rather expensive as many investors want to deploy their money at a limited number of royalty and streaming companies. I believe that buying them at yearly highs is not the best option right now.
All in all, I consider playing more leveraged miners in case of additional gold upside, but I remain extremely cautious as the trade is very crowded and may unwind very fast. When the dust from Brexit settles, traders will find that the world has not changed materially and may rush for exists in the positions that have doubled or tripled this year. I believe that current levels are not suitable for anything other than short-term activities. For longer-term deployment of money, a significant correction is necessary.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SBGL, IAG over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.