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Coronavirus Is Bullish For Gold Prices And Gold Stocks

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Includes: DGL, DGLD, DGP, DGZ, DZZ, FNV, GDX, GLD, GLDI, GLL, GOLD, IAU, OUNZ, PHYS, SGOL, UBG, UGL, UGLDF, WPM
by: Gold Mining Bull
Summary

The spread of COVID-19 (coronavirus) has created buying opportunities in the precious metals sector.

Gold is a classic safe haven investment during periods of turmoil.

Gold prices are holding up over $1,600/oz while stocks plummet. Gold has gained value relative to stocks.

Most gold mining operations have not been impacted by the virus, and the costs of production should fall with lower oil prices.

I break down why I feel gold stocks are a buy here.

Coronavirus Is Good News For Gold Prices And Miners

(Current gold prices. Credit: StockCharts)

With stock markets and oil prices plunging this week on increased concerns of the growing COVID-19 pandemic, investors are hiding out in gold, cash and bonds as safe havens. But gold miners and the streaming/royalty companies are also looking very attractive here and should be targeted by value & contrarian investors. When the dust settles, I think this will be one of the strongest performing sectors.

Gold is still cheap compared to stocks

(Credit: StockTrends)

Despite the heavy sell-off in stocks and the relative strength in gold prices, I don't think we're anywhere near the normal, or historic, ratio of gold prices in relation to stocks.

Investors should look at the Dow-to-Gold ratio, which is a measure of how many ounces of gold it would take to buy the Dow on any given month. Previous cycle lows have been 1.94X in February of 1933 and 1.29X in January of 1980." Back in 2011, the ratio hit a 10-year low of 6.36X. We are currently near 14X.

If we were to see this ratio get back to the 7X level, which seems like a real possibility based on ratios of the past, that would mean if the Dow Jones fell further to 18,000, then gold prices would need to trade at $2,571/oz.

Alternatively, if the Dow remained around current levels of 22,000, then gold would need to trade at $3,142/oz, to hit the 7X mark.

I believe we're about to see this ratio drop even further based on the potential for a much steeper decline in stocks and more investors to turn to gold as a safe haven with coronavirus spreading. This latest gold rally has strong legs and the increased likelihood of a global recession could send gold to new highs.

I expect the selling pressure on stocks to continue over the next few months as the outbreak gets worse and more cases are brought to light - we are now at 115,000 cases worldwide, as of writing. Gold prices are likely to continue to show strength relative to stocks, and potentially rise to new highs this year.

In my view, gold is a better alternative to holding any currency (including the U.S. dollar), as central banks are likely to resort to some form of currency devaluation in response to a weakened economy.

The Federal Reserve has already cut rates once as an emergency measure, and another emergency rate cut seems inevitable. Perhaps a new round of quantitative easing, a debt-funded stimulus package, or some other substantial fiscal action like a 0% payroll tax will happen if the economy goes into a recession as many are now predicting.

Why gold stocks?

(Credit: Yahoo Finance)

Gold stocks provide leverage to the price of gold (GLD), but surprisingly, gold mining stocks (GDX) have been underperforming lately as investors have been throwing the baby out with the bathwater.

Check out the year-to-date performance of gold miners compared to gold prices in the above chart. The GLD is up 7.7% compared to a 13.8% decline in the GDX, which is a basket of some of the largest gold stocks.

I remain optimistic that we'll see gold stocks rebound sharply in the near-future. With gold prices holding up well and oil prices falling, gold miners' operating margins are likely to be the highest they've been in years when miners report Q1 earnings.

(Oil prices haven't been this low since 2011. Charts as of Tuesday, March 10).

Lower oil prices is bullish news for gold miners in particular. It makes up part of a miner's cost structure, as it is part of the cost of mining gold (operating heavy machinery which requires diesel fuel, completing exploration drilling, and transporting gold ore). This means slightly better operating margins and higher free cash flow for miners.

Perhaps, most importantly, we haven't seen any gold mines disrupted by the outbreak of COVID-19 yet. I would avoid miners doing business in China for now, and perhaps parts of Europe as well, but I expect miners operating in North America, South America, Africa and Australia to largely be sparred by the virus.

Barrick Gold (GOLD) is one miner which has already got a strong plan in place to combat the virus. The senior gold producer says it has increased its site-specific emergency response plans as well as regional crisis management plans to deal with any manifestation of COVID-19 in or near its mines globally.

The streaming and royalty companies are also likely to be sparred any impact from the virus, especially the larger companies like Franco-Nevada (FNV) and Wheaton Precious Metals (WPM). These companies have hundreds of assets worldwide and are a bit more diversified than the typical mining company.

Disclosure: I am/we are long GOLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.