Gold and Silver Bulls Charge on: Here's How to Play It

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Includes: ABX, AEM, GDX, GG, GLD, PAAS, SLV, UGL, WPM
by: Investment Underground

With the Berkanke "put option" from QE2 winding down, we think more volatility in the VIX (VXX, VXZ) is in store for the markets over the short term. Our analysis shows that the low interest rate environment and the Fed's latest round of easing have yet to fully percolate into equity and commodities markets. While early signs of inflation have appeared in silver (NYSEARCA:SLV) markets earlier this year, we think the bull has yet to run its course. Here our some of our ideas of how to play this trend:

SPDR Gold Shares (GLD):
Gold Shares is an ETF that is priced at one tenth of the price per ounce of gold. Being priced at a fraction of the price of gold makes participation in the gold market more accessible for investors. GLD is the first, oldest, and largest gold ETF with $60.68B in assets.

GLD has a YTD return of 9.84%, 1 year total return of 32.08%, and a 3 year total return of 20.70%. Physical gold bullion makes up 100% of its holdings. GLD is a great buy to take advantage of the current upward trend in gold. Being tied directly to gold, prices should increase as Greece worries heighten.

Gold is the world's reserve currency, and, if demand can get ahead of supply, Gold may temporarily outpace Platinum (PPLT, PGM) as both head towards $2000 per troy ounce.

ProShares Ultra Gold (UGL): Ultra Gold is the next step up from GLD. UGL invests in gold instruments, mostly futures, with the goal of doubling the performance of gold bullion. That is to say that if gold increases 5%, then UGL should increase 10%; and vice versa for losses. Because of this multiple, Ultra Gold is a much riskier investment than physical gold or GLD, but also has more reward potential.

UGL has a YTD return of 18.95% and a 1 year total return of 65.98%. While GLD does not correlate perfectly to gold, we can see a striking similarity between the returns of GLD and UGL. Ultra Gold is almost exactly double Gold Shares. UGL is not for all investors; because of the leverage, the risk is high. If you are ready to aggressively invest in gold, then UGL allows you to take a bullish stance. Over the long-term decay in the futures UGL holds causes some slippage. As a result, the long-term returns are not quite 2x GLD.

In the alternative, we recommend more sophisticated investors short ProShares UltraShort Gold (NYSEARCA:GLL) and capture some of the slippage in this fund as it attempts ot track 2x the inverse of gold. Please see our primer on futures slippage as it relates to iShares Short-Term Volatility ETN (NYSEARCA:VXX) here.

Market Vector Gold Miner ETF (GDX): Gold Miner is an ETF which invests in the gold mining industry. All of its investments are in basic materials stocks and ADRs. At least 80% are invested in gold mining companies in this un-diversified fund. GDX aims to duplicate the price and yield of the NYSE Arca Gold Miners Index.

Gold Miners holds some big names in gold mining including Barrick Gold Corporation (ABX), Goldcorp Incorporated (GG), Newmont Mining Corporation (NEM), Randgold Resources Limited (GOLD), and Eldorado Gold Corp Ltd Ordinary (EGO). Its top two holdings ABX and GG, account for more than a quarter of its holdings. With the demand for gold rising, the pressure is on miners to increase production.

Some argue that production has slowed, and therefore these companies are not sound investments. The reality is that in 2002 gold production was not seen as profitable due to low gold prices, and the industry had already started to slow production before the prices began to rise. It takes time to increase production. At first the industry was reluctant to increase in order to see if the higher prices would last. This industry is ramping up production to meet the new demand.

Barrick Gold Corporation (ABX): Barrick Gold is in the business of producing, selling, mining, and exploring gold globally. It has 25 operating mines as well as interests in oil and gas production in Canada.

The current price in the $40s is down from its 52 week high in late April of $55.74. It has a steady dividend yield of 1.00%. Barrick recently announced that it will acquire Equinox Minerals Limited (EQN), which is a mining and exploration company whose main project is a copper mine in Africa.

ABX has also announced the sale of $4B in debt securities. This capital will help finance the Equinox deal and be used for general corporate purposes. ABX is a buy. The company has shown determination to become the biggest, best, and most sustainable gold production company in the world. The increase in gold prices will only edge its production higher.

Goldcorp Incorporated (GG): Goldcorp is a precious metals explorer and developer globally; including gold, silver, copper, zinc and lead. It also produces and sells gold and silver. GG is one of the major players in the gold mining industry.

GG has a trailing P/E ratio of 18 and a forward P/E ratio of 17.5. The current price is $47, which is on a yearlong bumpy rise, with a 52-week high at $56.20. GG also has a forward dividend yield of .90% paying $0.03 quarterly. Along with Barrick, Goldcorp owns a stake in the Pueblo Viejo mining project. Though there have been some delays due to inclement weather, once in production, the mine is expected to produce 600,000 ounces of gold annually. Additionally, significant amounts of zinc, copper and silver have been found near extractable gold reserves as well. Goldcorp is a buy due to its earnings growth prospects. It posted a 71% increase in revenue last year and as I said before, it is one of the major players in an industry that is set to rise.

Agnico-Eagle Mines (AEM) is another solid gold mining company. AEM has been hard at work expanding operations through exploration in countries that are conducive to mining, mostly the Americas and select European countries. It has a P/E of 29.2, which is not as favorable as ABX, but does have a modest debt/equity ratio of 0.2. Forward earnings projections place the PE around 18 for fiscal 2012. Relative to the industry, its price/book and price/sales are high at 2.8 and 6.5, respectively.

The numbers on AEM may not be as impressive as ABX, but I would recommend this as a growth play. With heavy investments in five new mines, Agnico-Eagle is positioned to see growth over the coming quarters. Shares yield 1.1% for patient investors who can wait for further growth to appear.

iShares Silver Trust (SLV) – Much like GLD for gold, SLV is an ETF that offers shares that are backed by physical silver. In the short term, silver will continue to benefit from the lackluster dollar and euro, in my opinion. Historically, silver has had much larger swings and is much more volatile than some investors can handle. Back in 2008, silver dropped dramatically with the market, while gold only took a small dive, but both have continued to grow since then. Over the past few weeks, silver has been declining. Be vigilant. If the economy is still floundering and currency still amuck, silver could provide good returns, if bought at the right price.

Pan American Silver (PAAS) is mostly a silver explorer and producer. The company has multiple mining operations in North and South America, as well as in Europe. The company has a solid price/book ratio of 2.3 and a good price/sales ratio of 5.5. It keeps an operating margin of about 30% compared to an industry average of 22.7%. It does have a less-than-stellar price/earnings of 30.6 as opposed to an industry average of 21.5. The outlook on silver is bullish, and at the right price this is a good stock for traders who are looking for a play that correlates with silver prices.

Silver Wheaton Corporation (SLW) is an interesting company for investors looking at silver futures trading. The company does not actually purchase physical silver but buys long-term purchase contracts for silver. This provides a valuable service in the silver market. Silver Wheaton helps miners’ hedge risk against future price fluctuations and helps smooth balance sheets.

SLW initiated a 3 cent per share quarterly dividend after a stellar first quarter earnings statement. It stands with a P/E of 33.2. Shares tout a 66% operating margin and EPS growth of 30.9% year-over-year. We recommend that investors buy as SLW approaches $30 per share or use a put-selling strategy to acquire shares.


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.