Investing in Gold

Investing in gold stocks can be very lucrative as the price of gold is increasing. Gold miners typically have fixed investment costs for equipment, labor and energy costs. As the price of gold increases, most of their increased revenue from gold sales flows straight to the bottom line as profits. For this reason, gold stocks are said to be levered to the gold price. For example, if the gold price rises 10%, the price of gold stocks can rise by 20% or more.

This can be seen when comparing the increase in gold prices over the past year vs the increase in the HUI. The HUI is a gold stock index with 15 component stocks. Five of these stocks will be discussed below. In the meantime, check out the graph at the right which compares the price of GLD (the gold bullion ETF) vs the HUI. Over the past 6 months, the HUI has vastly outperformed the price of gold. Of course, leverage works the other way so that when the gold price (or the stock market in general) declines, HUI can seriously underperform gold.

All of these stocks are traded on the NYSE:

Goldcorp (GG) is my current favorite of the bunch. As a matter of fact, I have about one-third of my retirement account invested in GG. Goldcorp is a Canadian based gold producer with mines in Canada, the United States, Mexico, Central America, and Argentina. They pay a small monthly dividend. The NYSE market cap is 27.6 billion dollars and have a trailing 12 month PE of 17.7. I think the PE is reasonable and like the monthly payout. I also like the fact that their mines are in politically stable locales.

Newmont (NEM) is also a large gold producer with world-wide operations and headquartered in Denver. The trailing PE is a little higher at 33.2. NEM also pays out a dividend. The payout ratio is higher than GG (27% vs 9%). NEM is the only one of the five that I have never owned, but I still like it. It is a safe way to invest in gold stocks.

Barrick (ABX) Gold is another large producer. I used to own this stock in my retirement account prior to replacing it with GG. I replaced it because Barrick had a fairly large hedge book. This means that when gold prices were low, they sold their future production for a set price. When gold started rising, the spot price of gold rose above what they had contracted to sell for. This means making less than what you could be making. This had a tendency to hold the stock back. They were making progress on reducing the hedge book, but I am not sure where that stands currently. There is a dividend, and the PE is 51.

Kinross Gold (KGC) is a little more speculative. KGC is another Canadian-based producer with mines in North and South America and Russia. It actually has posted a loss of 1.21 per share for the trailing 12 months, but did post earnings of 0.11 per share for the most recent quarter. With a cash cost of approximately $420/oz. going forward, I would expect KGC to generate significant positive cashflow. I have owned KGC in the past and almost purchased some more last week but went with AUY instead.

Yamana Gold (AUY) is another Canadian based producer. I decided to invest in this one last week since it had the lowest PE (except KGC) of these 5 stocks. If the gold price were to continue to rise, I felt that a PE of 25 or so might be justified so the price of AUY might rise substantially. Also, as the miner with the lowest market cap of these 5, I thought the stock might represent a nice takeover target.

So, consider some of these gold mining stocks for their exposure to the gold price as a hedge against inflation and to offset some of the volatility of the rest of your stock positions.