Gold Stocks: Too Much Speculative Risk for My Taste

I've structured my portfolio over the last several years with a healthy complement of natural resource stocks. I purchased leading companies with solid fundamentals in the oil, natural gas, base metals and timber industries. The investment themes surrounding my holdings are: (1) "Peak oil" is here or will be soon; (2) The robust growth of the Chinese and Indian economies will continue for many years; and, (3) Trees, well, they just keep growing. I do not own gold or gold stocks. The price of gold has been hitting new highs so I thought I would take another look.

Briefly, the principle variables influencing the price of gold are:

1. Because gold is priced in U.S. dollars, its price is inversely correlated with the value of the dollar relative to other currencies. A depreciating dollar makes gold more attractive to foreign investors since it takes less of their currency to buy a given amount of gold in dollars. Likewise, a strengthening dollar makes gold less attractive to foreign investors.
2. Investors turn to gold during times of political and economic upheaval because gold is an accepted currency in and of itself. The value of paper currency depends on the confidence holders have in the government and economy that the currency represents. Those that favor owning gold cite the large budget and current account deficits in the U.S., inflation and the declining value of the dollar. Some hardened gold bugs go so far as to predict the collapse of the U.S. economy. Since year-end 2002, the dollar has depreciated 40% against the Euro and 14% against the Yen. The Consumer Price Index ranged from +2.3% in 2003 to +3.4% in 2005, and came in at +2.9% in 2007. The price of gold is up 180%.

Owning the yellow metal itself is not right for me. I want to invest in stocks of companies that can grow and pay me dividends. Gold cannot do that. So I focused my research on gold stocks.

Gold stocks performed well in the last five years along with the price of gold. The Phlx Gold Silver Index (mostly gold stocks) is up 164%, as compared with 55% for the S&P 500. Are gold stocks a good investment? I used the Company Stock Risk Profile and Fast Track to find out.

I put together a group of seven gold stocks:

• Kinross Gold (KGC)
• Goldcorp (GG)
• Harmony Gold (HMY)
• Gold Fields (GFI)
• AngloGold Ashanti (AU)
• Barrick Gold (ABX)
• Newmont Mining (NEM)

I started my research with the Company Stock Risk Profile Fast Track. None of the companies passed my rule of failing no more than 3 of the 10 variables which would make it worthwhile for me to go forward with more extensive research.

Here's the real surprise. Free cash flow was negative at five companies. All seven companies reported earnings that disappointed at least once in the last four quarters, and analysts were lowering earnings estimates at five. I expected these companies to be money machines given that the price of gold has been well above the cost of extraction.

But I wanted to find out more about the leading companies in the industry: Barrick and Newmont Mining, the first and second largest gold producers. After putting both stocks through the entire Company Stock Risk Profile research process, I'm still not interested based on their Risk Profile ratings, free cash flows and valuations.

Barrick's rating was Medium Risk, having failed 23 of the 50 categories. Barrick's free cash flow, while positive, dropped from $1.0 billion in 2006 to $686 million last year. The stock failed 7 of the 12 valuation categories.

While Newmont Mining came within the range of a Medium Risk rating, the stock failed 29 of the 50 categories. Newmont's free cash flow was negative in both 2006 and 2007 at $408 million and $1.1 billion, respectively. The stock failed 8 of the 12 valuation categories.

Because gold is a volatile commodity, I want a Low Risk Profile rating incorporating solid company fundamentals and value before considering a gold stock for my portfolio. Otherwise, buying gold and gold stocks becomes solely a speculative bet on forecasting inflation, the dollar and world events. That's not the way I invest.

Disclosure: None

Comments

[HappyLeader]

Given that this so-called "expert" admits that he totally missed out on gold's recent spectacular increase in price, why would anybody give even 2 diddlies what his opinions are? In addition, he says that an investment in gold today is a hedge against inflation. Is there ANYBODY out there who doesn't believe with all the US $ being printed and thrown around in bailouts, and the obscenely low interest rates, that we're not at the beginning of an inflationary cycle?

[iman]

I agree with your natural resource investment idea, and yes gold stock is speculative. But if you believe in the fundimentals you can speculate and should but not with the majors you have listed. The mid tier and junior stocks have much more upside potential.

[Jake2]

No where in this article does the writer refer to himself as an "expert," let alone "so called expert." Seems to me Happyleader's comments in part are a case of the messenger being attacked rather than the message. Referring to someone as a "so called expert," and using language such as "why would anyone give even 2 diddlies" about this person, advance no argument and encourage no rational discussion of the subject.

[SD CDL]

You're missing a crucial factor of inflation and double digit M3 growth GLOBAL. The CPI is fiction, a Frankenstein of an index that systemically removes or modifies anything that goes up in price. Homes in this decade have been speculative, gold is in the early portion of a bull market. Bill Fleckenstein said it perfectly...in a social democracy...all roads leads to inflation. Inflate or Die!

Agree with structuring around peak oil but oil/gas will also rise with the inflationary cycle.

Gold is Money!

[[e-mail]]

gold stocks are very difficult to analyse,
All mines practice "yield management"

All ore bodies are variable in the amount of metal in a ton of ore.
when prices are low they mine the "rich" ore,
when prices go up they mine the lower grade ore.

The idea is to maximise the value of metal mined
OVER THE LIFE OF THE MINE.

Mining companies tend not to be transparent about
what their plan for the year is,
and I haven't seen an analyst who has the info
or smarts to figure this out.

[DONTKNOWMUCH]

I DON'T KNOW MUCH, BUT; I WONDER WHY HE FORGOT TO MENTION THAT KINROSS GOLD DID PAY A DIVIDEND, ABOUT 2 WEEKS AGO?

[poet1]

re: the authors comment on timber; - trees, 'they just keep on growing' , says a lot about the authors lack of reasoning. they may keep on growing, but, not fast enough to compensate for the amount being hacked down. i could go on, but, why bother

[SD CDL]

Rereading his last paragraph...how is gold more volatile then any other asset class? Real Estate doubled or tripled, then crashed. Financials exploded...then went (Bear Sterns) bankrupt. ALL asset classes are volatile these days, just as a inflationary cycle predict...money sloshes around from asset to asset. You can predict the price of gold in two questions: What is world M3 growing by and will congress continue to spend us into oblivion.
Note: I also don't think gold will rise forever, but we're only in the 2 or 3rd inning people.

[john2]

Okay i could have sworn on my life that gold was said to be respected becuase of its non volatile nature? so that yes in bad times it goes up and in good times it stays stable. despite being supressed by many human factors *cough federal banks. yet your saying that a) its speculative (high growth wise yes maybe) and b) its volatile. sorry thats not how it is. if you invest in gold then you invest for stability that is the point. oh and the way you invest seems to be soley on tools by the way. it doesnt seem to me like you have a clear understanding as to why anyone of your statistics are the way they are. one reason is that all those companies are growing companies that are funded through debt they arent concerned with capital but rather growing. Gas and merley the cost of producing higher quality gold is also affecting its prices.

[mongoose]

Does anyone know what the value difference is between .999fine and .9999 is?

[Banuwati]

Precious metals, in general, go up during inflationary periods and with world energy prices high and the world energy supply and demand curves crossing, it seems that inflation will be the next norm. Unlike the 1970-1980 inflation/stagflation period (when metals prices skyrocketed), the world energy supply vs demand is close to balanced (supply was artificially held back in during 1970's by OPEC). Any increase in demand or decrease in supply tends to be exaggerated when near the tipping point. We are there. Inflation and the prices of precious metals are probably in the early stages of a bull market....unless we experience a worldwide recession...which doesn't seem likely at this point. I'm betting on higher energy and higher inflationary pressures. Even if the world economy were to go into recession, it would be a short-term event and energy demand would continue to increase while supply grows slowly (if at all). All commodities are being gamed and China/India are on the prowl to obtain the resources to maintain their rapidly growing economies.

To confess, I am a geologist in the energy industry with 28 years of experience, and my observations/conclusio... are based upon my professional experience.

[whiteowl]

An article by a person who feeds seven stocks into someone's computerized valuation program and makes a sector call? Whooee!

By the way, Newmont and Barrick (especially Newmont) are not "leaders"; they are only "large". There's only one company on this list that I would only consider for purchase (KGC), and I don't own it anymore because I can do better with a gold stock not on his list.

[paultaut]

Give me a break...the miners to invest in are not the low cost producers and gold is not an inflation barometer.....

Gold has been a currency far longer than every civilization on the planet...Cromags,Neand... wandering the earth...shiney stone, I give for club...I club take stone.

The incremental rise in gold prices is just that to the low cost producers meanwhile the high cost producers will finally show profits and that is where Analysts will go and raise targets.

You want free cash flow good but the real value will be in Miners who will generate free cash flow for the first time in their histories.

Gold shot up in the 70's not because of inflation but because it was no longer pegged at $35.00 and just followed suit as oil went from $3 to $40. Who knows where Gold would have started from had it not been artificially subdued.

[paultaut]

hey whiteowl...are you by any chance involved in the miner which just go the Memorandum of Understanding form the tribe in canada?

[Lawrence]

I beg to differ paultaut. Gold is, suppressed as it is, still a measure of inflation or more specifically a measure of inflation of the world reserve toilet paper i.e. the dollar.
Gold is money, gold is a real true store of wealth (god knows why but it is and has been since recordable history began) and gold is the anti dollar. Therefore what we are seeing is not the rise in gold price but the decline in real value of the dollar (and all other fiat currencies). This is due to one simple fact and one alone - the rampant flood of global money, credit and liquidity into the global financial sytem. all other inflationary aspects including speculatory investments, market volatility, financial abuses such as cheap homeloans, bubbles etc etc are all symptoms of this one disease.

the chickens are coming home to roost however as market forces overide anything the puny Fed tries to do. Over the next two years you will witness massive monetary and price inflation as they struggle to keep the wheels from coming off the financial machine. Hyperflationary depression is the only frseeable outcome i am afraid to say. They have pushed inflation and financial leverage too far and the picture is there plain and clear for anyone with the guts and honesty to see

[geofotos]

chicken conclusion. if we didn't have to import our life's blood items I might take a neutral stance. weak leadership and fearfull citizens have the almighty dollar turning into a spit ball.

[pseudoym]

for poet 1:
I did just want to mention that a little research before posting information would be nice. I know that most people stand on one side of the fence or the other, but don't just stand on the side your buddy is standing on, if you don't know why he's there...I will explain.
The timber industry is not "hacking" down more trees than they put back. Actually production rates are down, because the value of timber is falling right now. My entire family is in the logging and forestry industry in Oregon And Washington. Timber isn't the quality it used to be, because of re-logging, and seeds that are made to make trees grow faster. But there are actually more trees planted when they lof an area. Infact there are laws requiring that all logging outfits must replant an area, BEFORE they move to the next.
It's really not as bad as people make it sound. And he is right. Timber does "keep growing back." Check into the markets right now. Good time to buy, because prices are down.

[thinkgirl]

Lawrence has got it right. When gold breaks out against the other currencies we will see a sharp rise, so don't be quick to dump, this rise will likely continue until and if the IMF and or other Central Banks start dumping. Most Central Banks are no longer even meeting their allowable sales volumes on Gold. Greenspan once said that he strongly opposed the idea of the U.S. selling any Gold, as he reminded government and military officials, that if the dollar is ever frowned upon, military can still function on Gold! Any downturn should be looked upon as buying opportunities, because what gets dumped is being quickly snatched up by Russia, China, Argentina and others who are leveraging their portfolios of worth-less American dollars. These gold buying countries are also being "rumored" as bringing out a gold backed currency, though China may go back to her former silver backed position. Hyper-inflation is a real possibility. For one thing it would give the American Central Banks and big business the opportunity of introducing the Amero, and if they do, I for one will hope to see it backed by gold! As far as gold mining stocks go, Gold will still have to show stability price beyond $800.00 before it will be prudent for most companies to commence serious operations. Labour, and operating costs have been a major factor with many companies still working from a spot price of around $350.00. But within 6 months or so I expect to see a lot of them kicking into production.

[firboy4]

There sure are a lot of experts on here! All I think I know is that if China, India, and some of the rest of the world NEED more gold to make the lives of their people better, then it will continue to go up. The only thing I learned from reading this article(nothing there) and these posts is that it might just be a good time to buy timber companies, due to what that timberman said.