2 'Must Own' Gold Stocks For A Weak Economy

Includes: ABE, ABX, AU, GG, GLD, KCG
by: Ry Frank

The U.S. Labor Department reported Friday that the unemployment rate had risen to 8.2%, as businesses added a scant 69,000 jobs in May. The data led to increased speculation that the Federal Reserve may step in, specifically considering taking steps towards further quantitative easing - yes, the dreaded QE3. Perhaps the most significant impact of the information was that stocks had their worst day of 2012 and the VIX index, the standard measure of volatility in the market, spiked by over 10%. The fall puts all of the major indexes into correction territory, with the Dow crossing into negative territory for the year while the S&P 500 is holding on to a less that 2% year-to-date (YTD) return.

This confluence of events led gold to spike by over 4%, making it the single largest up day for gold in the previous two years - spot gold climbed by approximately $66 per ounce to close near $1627. The apparent deterioration in the job market can be seen specifically as a possible catalyst for Fed action; the Fed has specifically said that they would not consider more bond purchases unless there was a breakdown in the U.S. job market. Friday's data suggests that the breakdown may be taking place.

The way this process works is that the Fed begins a course of quantitative easing to help stimulate the economy. This leads to inflation, which cause the value of the dollar to decline. In order to escape this devaluing, investors look to buy and own gold, as it is seen as an excellent hedge against inflation and a superior store of wealth. Additionally, as the weakening situation calls into question the overall strength of the economy, investors pull out of stocks to further protect themselves. These investors also look to the safe haven of gold to protect their capital. These combined actions cause the price of gold not only to rise, but to become increasingly attractive despite the high price.

The Continued Attractiveness of Gold

While many investors had begun to question their allocation to precious metals, specifically to gold, events like these underline the importance of both remaining diversified and keeping some capital deployed in gold or gold stocks. While the general market was getting hammered, gold stocks had an impressive day. Barrick Gold (NYSE:ABX) rose by 7.1%, Goldcorp (NYSE:GG) rose by 8.9% and Newmont Mining (NYSE:NEM) rose by 6.8%. Similarly the SPDR Gold Trust (NYSEARCA:GLD), the most liquid gold exchange-traded-fund (ETF), rose by 4%. These types of gains can go a long way to mitigating some of the losses that one's equity portfolio likely experienced. In nearly every comprehensive study of investment performance ever conducted, asset allocation and diversification have proven to be one of the most critical drivers of investment performance over the long-term.

Given Friday's price action, one might feel that the opportunity has been missed and that gold is no longer attractive. While the price jump should factor into one's timing, it is more likely that it represents the beginning of a new trend rather than the end of one. When the job situation is put into the context of the political landscape, the most likely outcome is Fed action. During an election year, the incumbent administration is likely to take whatever steps it thinks it can justify to stimulate the economy. Particularly in light of the fact that this administration, this Fed and this Treasury have shown their respective willingness to send the deficit into the stratosphere, it would seem improbable that any of these key players will shift focus at this point. Even should the irresponsibly dangerous nature of their past behavior dawn on them, a shift at this point would be even harder to explain in the national spotlight. "Free money for all" may be a risky move, but it is likely to relate in more votes, not less.

The sum total of the market evidence available suggests that regardless of one's political leanings - and I am willing to accept that there are multiple legitimate positions - having an allocation to gold is a prudent decision. The diversification element and the current economic and political landscape make the allocation a clear choice.

The Right Name

Given the need to make an allocation the gold space, one must pick the best vehicle to use for this capital deployment. Based on the fundamental metrics, Barrick Gold is at the front of the pack and appears to be the strongest choice amongst its peers. On a valuation basis, using the trailing twelve month price-to-earnings (P/E) ratio as the measure, Barrick is very attractive. The company currently has a P/E of 9.3 relative to 954 for AngloGold Ashanti (NYSE:AU), 74.6 for Newmont Mining, 20.8 for Goldcorp and a negative earnings result for Kinross Gold (NYSE:KCG).

Barrick also stands out on an operating basis, with an operating margin of 45.5% relative to 32.8% for AngloGold Ashanti , 39.8% for Newmont Mining, 45.6% for Goldcorp and 33.9% for Kinross Gold. The only other company with that level of efficiency of operation is Goldcorp, that had been hurt by negative news. While both companies look very attractive at current levels, the slight edge goes to Barrick. It has a more attractive valuation and segments of its operation seem to be better positioned for long-term performance. Anyone considering allocations to multiple stocks may wish to include both names, but having an allocation to gold has never been more important.

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