A Bear Market in Trust: Good for Gold Stocks

by David Fessler, Investment U Senior Analyst
Monday, December 5, 2011

The world markets held their collective breaths over the political spectacle regarding raising the U.S. debt ceiling. Ultimately, a half-baked plan that essentially kicks most of the cans down the road emerged.

Our trust that politicians would come up with something productive went out the window. As a result, the credit rating of the U.S. Government was lowered. In response, central banks around the world stepped up their purchases of gold.

Trust is still the issue. Now it’s the European financial crisis that’s in the cross-hairs. That will keep a floor under gold prices through 2012, and we could even see the metal breach the $2,000 an ounce mark. Once that happens, the bull-run in gold will likely take off like a rocket.

You could play this rise in gold by buying physical bullion, but not everyone’s comfortable with having tens of thousands of dollars of gold coins or bars at home or even in a safety deposit box.

A better bet is a proxy for the metal itself. The easiest way to do that is via the popular SPDR Gold Trust ETF (NYSE: GLD). It holds the physical metal in a large underground vault in London. Shares are issued and are priced at roughly 10 percent of the current price of the metal.

The investment objective of GLD is to mirror the price of the physical metal. The custodian of the trust and the holder of the gold is HSBC Bank USA, N.A.

The Best Way to Play the Gold Boom: Gold Mining Stocks

While GLD rose 23 percent in the last year, many gold mining stocks underperformed the metal.

Take Yamana Gold Inc. (NYSE: AUY), for instance. Its shares rose a respectable 29 percent over the last year. Its total proven and probable reserves of 14.9 million ounces of reserves are located in Brazil, Argentina, and Chile.

With a current share price of just $16.14 though, Yamana’s reserves are priced at $807.75 an ounce or just under half of what gold bullion is currently selling for. Not bad. But you can do even better.

Let’s look at another big producer, Newmont Mining Corporation (NYSE: NEM) for example. With estimated gold reserves of 93.5 million ounces, its shares were up a paltry 7.5 percent in the last 12 months.

With a current price of $67.03 per share, investors are pricing its gold at roughly $355 an ounce, or roughly 20 percent of the price of the barbarous relic. If that sounds like a bargain, it is. And you’re essentially getting all the other metals they mine for free.

Let’s take a look at one more gold mining stock: Barrick Gold Corporation (NYSE: ABX). With 140 million ounces of proven and probable reserves, Barrick holds the largest reserves in the industry.

Last year, Barrick shares dropped 5.5 percent. How are investors pricing its gold reserves? With a current share price of $51.02 and 999.8 million shares outstanding, you can buy Barrick’s gold for $364 an ounce, or about the same as Newmont Mining. It’s also a bargain.

Junior Miners A Riskier Proposition

Here’s an important point to keep in mind when investing in gold mining stocks: the three mentioned above (there are others I haven’t mentioned) are large, producing miners.

They’re not junior mining wannabees, who might someday open a mine. Investing in shares of junior miners carry a lot more risk, and some will never amount to anything.

With governments in Europe and the U.S. running their money printing presses round the clock, investor trust is out the window. Central banks feel the same way, and are buying gold at record paces.

The upside for shares of all three companies in a gold bull market is huge. Plus, they all keep adding to their proven and probable reserves.

Whether you decide to hedge your portfolio with the physical metal, the SPDR Gold Trust ETF, or gold miners, you should have at least 5-10 percent of your assets in gold. In the coming gold bull market of 2012, the upside for the miners is far greater than the metal itself.

Good investing,

David Fessler