Brett Arends: In gold investing, forget the metal and focus on stocks


By Brett Arends
The Wall Street Journal
Friday, December 7, 2012

Want to buy some cheap gold? Consider gold-mining stocks.

Shares of the leading precious-metals companies have lagged behind the price of physical gold bullion so steeply in recent years that they now trade for significantly less than the value of the companies' gold reserves, analysts say. In fact, they say, the gap is among the widest ever seen.

And although mining stocks can be more volatile than bullion in the short term, over the medium to long term they could boom if gold -- which remains about 10% below its 2011 peak -- resumes its bull run.

Gold has risen 10% this year, but the Philadelphia Gold & Silver Index, which tracks the stocks of the world's leading precious-metal mining companies, has fallen 8% on concerns that mining costs and political risks are increasing. Over the past five years, while gold has more than doubled to $1,721, the Philadelphia index has fallen 2%. It is near its lowest level versus the gold price since FactSet began tracking the data in 1984.

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To put it simply: The price of an ounce of gold today would buy more stock in gold-mining companies than at any point in a quarter century.

Under this measure, mining stocks are as cheap "as we have ever seen them -- at least in my career, which is nearly 30 years," says David Christensen, manager of ASA Gold and Precious Metals, a $460 million closed-end mutual fund based in San Mateo, Calif., which invests in mining stocks and has been operating since 1958.

George Topping, a gold-mining analyst at Stifel Nicolaus in Toronto, says the only other time the discounts were close to this extreme was in 1999, when the gold industry was near the end of a long bear market. The current prices for major gold-mining stocks would make more sense if gold were about $1,300 an ounce than the current level of more than $1,700, he says.

Mr. Topping notes that shares of Toronto-based Barrick Gold Corp. and Denver-based Newmont Mining Corp., the world's biggest gold producers, trade for about 60% of his estimate of the per-share value of their gold reserves, after accounting for costs and the time it would take to extract the metal. Other major producers are at similar discounts to the value of their reserves, he says.

Analysts and fund managers point to a number of reasons for the poor performance of gold-mining stocks. A surge in miners' operating costs has shaved off some of the extra profits. The rising popularity of gold-bullion exchange-traded funds has taken away investment dollars that might otherwise have flowed into mining stocks. Growing political risks, such as strikes in South Africa and a possible mining tax in Australia, have kept some investors away. John Hathaway, manager of the $2.5 billion Tocqueville Gold fund, says investors also have shied away from the stocks because they fear gold itself might fall.

Yet industry experts say the biggest factor has been the rising cost of the industry's new investment boom. Mining companies have used their surging revenues to launch long-term projects and expensive takeovers, many of which could offer low returns on their sizeable investments.

Mr. Hathaway's firm calculates that over the past five years the top 10 gold-mining companies have almost tripled their total capital expenditure from $7.8 billion in 2007 to nearly $22 billion this year. The figure in 2003 was less than $2 billion.

In a May research report, Stifel's Mr. Topping urged big gold miners to drop their most expensive and least attractive projects and to return the money to stockholders through higher dividends. He calculates that if companies did this they could easily pay out annual dividends equal to 5% of the stock price or more, compared with the 1% to 3% typical now.

"If they just froze their production profiles, they'd be gushing cash flow," agrees Tocqueville's Mr. Hathaway.

There are some signs that industry executives in recent months have started paying attention. Over the summer Barrick announced a tougher stance on capital expenditure, and deferred indefinitely its major Cerro Casale project in Chile and Donlin Creek in Alaska. Newmont said its Conga project in Peru would continue only on a "measured basis." Kinross Gold Corp. K.T +0.63%announced plans to cut costs and rein in capital expenditure, and is considering shrinking a big project in Mauritania.

Ralph Aldis, co-portfolio manager of the U.S. Global Investors Gold and Precious Metals Fund, a $200 million fund, says he thinks the change is real. "In the last few months, these guys have had an epiphany," he says.

To be sure, the results have yet to be seen and investors remain skeptical, as the recent declines in the stock prices show. Should the companies continue to overinvest, or should gold itself fall, the stocks might disappoint. Yet at current levels the stocks already have factored in a great deal of bad news, analysts note.

Investors wishing to buy gold stocks have an array of choices. Specialist gold mutual funds buy stocks across the sector. A few, such as Mr. Hathaway's Tocqueville Gold, also own some bullion. Andy Claybrook, founder of Fee-Only Financial Solutions, a financial advisory in Franklin, Tenn., likes Tocqueville, which carries annual expenses of 1.26% a year, or $126 per $10,000 invested, and the $1.6 billion USAA Precious Metals and Minerals Fund, which charges 1.17%, citing the fund managers' expertise.

Low-cost exchange-traded funds buy baskets of gold stocks and typically have low fees. They include the $9 billion Market Vectors Gold Miners Fund, which charges 0.52% a year, or $52 per $10,000 invested, and the $37 billion iShares MSCI Global Gold Miners Fund, with annual expenses of 0.39%.

For those who wish to buy individual stocks, Mr. Topping recommends sticking to the bigger companies and prefers Vancouver-based Goldcorp. Its mines are mostly in North America and he predicts output will increase 60% over the next four years. The stock trades at around 75% of the per-share value of the company's gold reserves, he estimates.

If gold regains its gleam, mining stocks might glitter.

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