The market prices for gold mining companies are very compelling, even for value investors who do not wish to speculate on precious metal prices. Stock investors can capture attractive gold miner valuations at current market prices and can elect to either accept exposure to gold as a benefit to a diversified portfolio, or they can hedge out exposure to gold prices using put options. Either as a pure value play or as a value play with a gold kicker, going long gold miners is an attractive strategy.
Gold mining industry stocks have declined in price and are currently trading at attractive valuations. Goldcorp (GG), Kinross Gold (KGC), IAMGOLD (IAG), and El Dorado Gold (EGO) are attractive value buys at today's prices:
Kinross Gold trades at a discount to the book value of its equity, which is a steal for a company with assets like gold that have appreciated beyond the cost of their original acquisition. Alternatively, IAMGOLD is clearly a value buy on the basis of a low price-to-earnings multiple.
Goldcorp and El Dorado Gold are attractive gold plays because they are low-cost producers of gold. Goldcorp's forecasted 2.60 Moz production (pdf) for 2012 is expected to incur $250-270 in cash costs per ounce as a byproduct and $550-$600 in cash costs as a co-product. Similarly, El Dorado Gold forecasts 730,000-775,000 ounces of gold produced in 2012 with estimated cash operating costs between $430 and $450 per ounce. These costs are low by industry standards and are clearly lower than prevailing gold prices which are currently between $1600 and $1700 per ounce.
Better yet, these gold stocks pay dividends. Goldcorp, IAMGOLD, and El Dorado Gold have low payout ratios, which mean that their dividend yields are not likely to be cut and have room to grow. The income aspect of gold miners differentiates them from holding physical gold or the SPDR Gold Shares (GLD) ETF, which are not associated with an income or cash flow stream.
Why are gold stocks so cheap?
Historically these stocks have been cheap because they are the bastard children of precious metals and stock investment philosophies. It is very hard for dogmatic investors to truly get behind this sector. On one hand, faithful stock investors are weary of high gold prices and do not trust the profitability of commodity markets. To them, gold is an archaic investment and mining is a dirty, backward business. On the other hand, gold believers are notorious for despising the stock market and paper investments. They distrust equity investments and financial assets generally. Clearly, these two mindsets cannot happily coexist. Investors seriously considering this industry have to put their beliefs aside and evaluate opportunities with an open mind.
Today, gold stocks are cheaper than normal because the costs of gold production are trending upward as much as 20%. Claimholders, suppliers and employees of gold mining companies are aware of the boom in gold prices, and respond by negotiating higher prices. (Contrary to political rhetoric, "windfall profits" are fleeting and are often more deserved than an election victory.) Moreover, over time gold is collected from increasingly depleted mines, which require more work to produce less gold.
There are also firm-specific events that can move stock prices. Goldcorp's progress toward mining in Chile was impeded by environmental concerns. This news negatively impacted share prices, which were already attractively low. This news should not have had much of an impact since the mine's production was forecast to start in 2017 (pdf), and its delay is hardly a threat to the firm. Currently most of the firm's production comes from Canada, and Mexico, and reserves are diversified across multiple countries and mines.
To Hedge or Not to Hedge
I do not have a crystal ball and I can't say what future prices of gold will be. On the contrary, I can reduce exposure to gold prices by hedging investments in attractive gold mining stocks. This can be accomplished by buying puts on more expensive gold miners like AngloGold Ashanti (AU). This gold stock has high cash costs between $820 and $835 per ounce. Investors could hedge risks in the industry through buying out-of-the-money puts on AngloGold shares. Since this company's earnings will be more sensitive to drops in the market price of gold, puts can serve as insurance against an industry-wide decline. Investors can also hedge their exposure to gold prices by buying out-of-the-money puts on the SPDR Gold Shares ETF. Though the price performance of physical gold often beats the mining industry, the options on this ETF are very cheap, making for a very inexpensive hedge.
Several gold miners are attractive value plays that pay reliable dividends. Investors should consider these investments regardless of their beliefs about gold. Gold bugs can invest in these companies to gain value and gold exposure in the same trade. If you find that gold has lost its luster, exposure to gold can be hedged out to leave cheap stocks trading at attractive prices.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.