With the IMF cutting global growth figures and market pessimism ahead of the domestic jobs report, gold seems to be one of the safest bets. Gold has been historically bought to save investors from so-called "tail risks", or unlikely but devastating economic swings. As the chart below illustrates, however, people who even held gold during the supposed "recovery" saw double-digit to triple-digit gains.
My general view has been that the global economy is much stronger than what the market appreciates. Corporate profits are going up, job figures are (while not great) improving, and inflation has been under control (despite the Fed's extended policy of low interest rates). Accordingly, I believe that gold investors should look beyond forecasting the price of precious metal (which can be very arbitrary in the context of volatility) and base their industry investments on volume trends or the fundamentals.
The good news is that there are a few basic material producers that are incredibly cheap irrespective of where the gold spot price falls under a reasonable margin of safety. One stock that I have been particularly bullish about is Freeport McMoRan (FCX), which has gone up an impressive 10.4% over just the last 5 trading days.
The company reminded the world of the challenging labor issues during its Indonesian Grasberg strike confrontation a few months back. Instead of finding new labor, Freeport went ahead and offered generous concessions that included an immediate bonus, higher wages, and improved working conditions. My fear is that these concessions will result in more protests, but I don't see this as a short-term issue in light of the sluggish economy.
Instead, Freeport is on track to solidly improve volumes across its impressive geographical operations that span from North America to South America. Production has been so impressive, in fact, that management has been ramping up annual copper production from 2.6B ounces in 2012 to around 3.5B in 2016. 2012 gold production is expected to be 1.1M. This translates to $3.7B worth of copper sales this year and $1.8B worth of gold sales. The company still generates $6.6B worth of cash flow and north of $20.9B in revenue, which leads to a very low PE multiple at 8.9x. Given volume improvements and expectations for solid growth, I strongly recommend buying Freeport.
Barrick (ABX) is also a strong investment in the gold sector with impressive fundamentals. The company is even more oriented towards gold than Freeport is, which it means it has more to gain from the inflationary effects of stimulus packages. It has limited exposure to the domestic economy, however, requires meeting a low bar to generate considerable value creation. The firm's PE multiple is just 80% of its industry's despite an impressive 7.7M oz yield of Au in 2011 and solid ramp up in Pueblo Viejo.
Execution has generally been in-line to above expectations but the "doomsday" scenarios envisioned by the bears all failed to materialize. Instead, EPS is expected to hit $5.69 in 2013 and then grow 27.8% thereafter. That means 2014 EPS of $7.27, which, at a 11x multiple, translates to a future stock value of $80. A 10% discount rate would yield a price target of $58.60 - in-line with consensus and at a roughly 60% premium to the current market value. Thus, Barrick is already cheap when factoring in the present value of future growth assumptions.
Another more expensive producer that is worth a look is Goldcorp (GG), which trades at 12.4x forward earnings and has solid liquidity at a current ratio of 3.1. Assets are also not tied up in inventories, as evidenced by the quick ratio of 2.5. The dividend yield may be weak at 1.4%, but Goldcorp is still nearly half as volatile as the broader market. Accordingly, the firm is a solid hedge against a shaky economic backdrop.
Aside from being a hedge, Goldcorp is not significantly undervalued like its peers. EPS is expected to hit $3.13 in 2013 and grow annually by 12.7% over the next 5 years. That means 2016 EPS of around $4.72, which, at a 11x multiple, yields a future stock value of $51.92. Discounting backwards by 10% suggests the company is more than 20% undervalued. Then again, I believe the EPS forecast of 12.7% growth is overly pessimistic since the historical record has been more than triple that amount over the past 5 years. Investors should thus consider buying shares across Freeport, Barrick, and Goldcorp with a relatively small long position in the last of these three.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.