Just because central bankers are printing money does not mean that every gold mining stock is a buy. Investors still have to consider valuation even if central banks around the world have committed to increasing the money supply.
The Historical Case for Gold Amid Monetary Easing and Inflation
Since 1984, increases in the price of gold have correlated with increases in the money supply. If this phenomenon continues today, money printing by multiple governments could boost gold stocks and gold itself as investors look to gold to give as a store of value.
In 1971, Richard Nixon ended the gold standard in an effort to stop the link between monetary and gold value, and said in a speech that the "American dollar would be worth just as much tomorrow as it is today." However, 40 years later, the American dollar is only worth 17 cents, and this decline in purchasing power is widely used as an argument for gold as a superior store of value.
Before the gold standard was discarded, deficits rarely occurred, and when they did it was during extreme situations, such as war or depressions. During peacetime, and when an economy was "sound," budgets were either balanced or deficits were relatively small. Since 1971, surpluses have been extremely rare. This is not a uniquely American phenomenon. The U.K. has had a yearly budget deficit for 50 of the last 60 years, and Spain has had deficit spending for 45 of the last 49 years.
Investors who want to reap excess returns must find the most compelling stocks, even in industries that experience significant tailwinds. The gold mining industry is no exception, and the price appreciation of gold miner stocks tends to lag the price appreciation of gold itself.
Gold miners are not magic profit machines. Instead, they become profitable by controlling costs and negotiating higher prices, just like other businesses. Industries whose firms have more bargaining power with customers, more bargaining power with suppliers, low rivalry between firms, few substitutes for their goods, and high barriers to entry tend to be more profitable. These factors are dubbed Porter's five forces, and they characterize the profitability of an industry.
Despite the logic of this model many investors - including professional investors - crave firms in commodity industries like gold mining. They don't seem to care that commodity producers are rivalrous because their products are fungible commodities, or that new competitors could spring up without any proprietary barriers to entry. These overzealous investors don't seem to mind that suppliers to these firms like land-owners and union laborers can demand high prices.
With this in mind, investors should not just buy gold companies at random.
Digging for Value
Many gold miners are Canadian companies. We can compare these Canadian firms exclusively to make comparisons more fair since they will be reporting using the same accounting standards.
The best investment among large-cap Canadian gold stocks is Barrick Gold (ABX), which recently traded near $42 per share. Don't worry about missing the stock market rally: this gold industry large-cap stock declined in price 6.8% over the past year. Barrick Gold shares are trading at an attractive 10.15 price-to-earnings ratio, lower than the 14.1 average of the S&P 500 index. Its price-to-book multiple of this stock is 1.69, cheaper than the 2.05 S&P 500 average. Though Barrick's 2.83 price-to-sales ratio is higher than the S&P 500, it is cheaper than many of its peers. Barrick's attractive valuations are particularly nice since it is also the favorite gold miner among analysts.
Income investors will appreciate that Barrick's stock pays a 1.92% dividend , more than the 1.64% 10-year treasury yield. Future dividend payments are likely because the company pays out 0.15 of earnings as dividends, so earnings could drop considerably before dividends must be cut.
Kinross Gold (KGC) is more of a speculative investment that trades at deeper values. This large-cap stock trades at about $11 per share after a 6.2% decline in price over the past year. There was net loss for the last twelve months, so the price-to-earnings ratio is incalculable. Its 2.97 price-to-sales is about the same as Barrick's ratio. However, this firm is attractive because of its 0.95 price-to-book multiple, much cheaper than the 2.05 S&P 500 average. Though the firm often runs a loss, its reasonable 0.13 debt-to-equity ratio demonstrates that the firm is not overleveraged.
Yamana Gold (AUY) stock is too expensive at a price of roughly $19, a price level which seems impossible to justify. Higher valuations for this large-cap stock come in part from a 30.5% jump in price over the past year. Investors can buy more revenue per dollar from the S&P500 since this index has a price-to-sales ratio of 1.29 while this stock has a much higher 6.42 ratio. This ratio is more than twice the price-to-sales ratios of Kinross or Barrick. Yamana Gold shares are trading at a lofty 33.89 price-to-earnings ratio, a price multiple more than twice the 14.1 PE ratio of the S&P 500. Recent acquisitions, which have yet to pass feasibility studies, are too speculative to justify these price ratios.
Eldorado Gold (EGO) stock is also too expensive at a roughly $15 price level. Equity in this company is rich on a price-to-sales basis since shares trade at a 9.5 multiple, higher than the S&P 500 average of 1.29. Eldorado Gold shares are trading at a rich 29.35 price-to-earnings ratio, more than twice the 14.1 average of the S&P 500 index.
Another pricey Canadian gold stock is Goldcorp (GG). This large-cap stock trades near $46 per share. Investors can buy more revenue per dollar from the S&P500 since this index has a price-to-sales ratio of 1.29 while this stock has a much higher 7.0 ratio. GG shares are trading at a rich 27.82 price-to-earnings ratio, almost twice the 14.1 average of the S&P 500 index. These valuations are higher than those of Barrick even though Goldcorp does not rank as high among analysts. Therefore, it's better to go with Barrick here.
Gold investors should consider buying shares of Barrick Gold as a solid investment and Kinross Gold as a more speculative investment. However, at today's valuations, investing in other Canadian large-cap gold miners is not recommended. Investors should wait for lower valuations before considering them.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.