Which To Buy -- Gold ETFs or Gold Mining Stocks? (ETFs: CEF, GLD, IAU; Stocks: ABX, FCX, NEM, NTO, RGLD)

Barron's bullish article about gold, which I summarized earlier today, concludes with a discussion about the best way to invest in gold if you believe the price is rising. Three alternatives are presented:

1. Buy physical gold. This is Marc Faber's opinion, as he views gold as a hedge against financial collapse, in which case financial instruments such as futures, stocks and ETFs may have little practical value.
2. Buy gold ETFs or a closed-end fund. There are two gold ETFs -- GLD and IAU -- and one closed-end fund, the Central Fund of Canada (CEF).
3. Buy gold stocks. Gold stocks have the advantage that they may provide more leverage to a rising gold price than gold itself, but also carry company-specific and industry-related risks.

Trey Reik, who runs Clapboard Hill Partners, a long/short equity fund that focuses on mining shares, believes that a rise in the gold price to $1,000 per ounce would result in roughly a doubling in value of the ETFs, but a gold mining stock like Newmont Mining (NEM) could triple.

Risks related to gold stocks include exploration risks, risk of the depletion of reserves, the industry-wide problem that production costs have risen steeply, and political risks, since most mining companies operate in developing countries unfriendly to capitalism.

Other than Newmont Mining, managers interviewed for the article recommended the following mining stocks:

• Barrick Gold (ABX)
• Royal Gold (RGLD)
• Freeport McMoRan (FCX)
• Goldcorp (GG)
• Northern Orion (NTO)

Frank Holmes, CEO of U.S. Global Investors, is particularly bullish on Goldcorp and Northern Orion. His firm owns more than 10% of Northern Orion, which he says trades at five times cash flow, compared with a peer-group multiple of 12.

But Barron's conclusion is this: "The easiest way to participate is through StreetTracks Gold Trust (GLD), an ETF that's pulled in $3.9 billion in just a year."

Full Barron's article here (paid sub req'd).

Comments

[dwot:]

Gold stocks no longer provide the leverage performance of the past, plain and simple. Leverage returns decline rapid the further you get into a bull run. Early, leverage returns were 10-fold, and it made gold stocks a great performer. Now at best you can get 1.2 kind of leverage.

How leverage played out early in the bull run on gold and how it can not repeat that performance is really poorly understood.

Furthermore, currently costs for gold stocks are increasing faster than gold the price of gold bullion, so I believe this will result in a negative leverage.

2007 Jan 06 02:32 AM

[dwot:]

I actually think gold stocks are in a gold bubble, and I can back that statement with fundamental analysis.

I did a comparative valuation between NTO and GG, and fundamentals are so grossly different, I find it amazing that the difference wouldn't be picked up by anyone who is making those kinds of recommendations. I'd send it to you, but I couldn't find an email link, but this is a summary of what is working against gold mines these days:

1. The leverage of earnings have grossly decined.
2. The price elasticity of gold bullion to gold stocks, ie, market cap is 3 to 20 times better for bullion than for gold stocks. (Kinross had the best price elasticity out of the gold stocks I calculated.)
3. The increasing cost of acquisitions, from $33/oz at the start of the bull to a max of $175/oz for Glamis.
4. Increasing rates of depletion of reserves.
5. Lower quality gold properties available to replace reserves.
6. Rapidly declining level of reserves to market cap.

2007 Jan 06 02:49 AM