5/21/2012 4:31 PM ET|
Time to mine the gold miners
Gold-mining stocks are trading at record lows, relative to the price of gold, and gold is off its highs. This could set the stage for big gains
Is it time for investors to start mining the gold miners? Though gold has been weak since hitting its high of $1,900 in September, it's still up 80% since 2008. Gold-mining stocks haven't fared as well. The Philadelphia Stock Exchange Gold & Silver Index (XAU.X) of the leading miners is up just 20% over the same span.
Gold has historically outperformed gold-mining stocks, but the ratio between the two is at an all-time high. That could be an opportunity for investors, especially if gold prices move back up as many believe they will, given economic and political troubles in Europe and the Federal Reserve's willingness to print ever more money to stoke the sluggish domestic economy.
In this year's first quarter, it derived 70% of its gold production from North America and the Asia Pacific region, though the 91-year-old company also has operations in Peru, Mexico and Ghana. The company's earnings are expected to hit a record $2.4 billion, or $4.85 a share, this year on a 6% increase in revenue, to $10.9 billion. Analysts see earnings climbing 15%, to $5.56, in 2013. And the company, which yields 3.1%, has one of the best returns on capital in the industry.
Recently around $46, Newmont's shares have been near their 52-week low, trading at just eight times 2013 estimates. If gold prices recover and energy prices fall, they could rise 50% or more.
A golden opportunity?
Gold is trading at record highs, relative to the price of the mining stocks. A ratio above 5 means that the mining stocks are cheap.
Morgan Stanley recently noted that "the fundamental factors that have driven the gold bull market of late remain very much in place." The report cited European sovereign-debt issues and continued negative real interest rates in the U.S. Also of note: Central banks continue to buy gold. Moreover, despite healthy demand and a generally rising gold price, global gold-mine production rose just 0.7% annually from 1999 through 2011. The upshot? Morgan Stanley recommends buying gold. It adds that the last time credit conditions were similar, gold rallied to near $1,800 an ounce, from a current $1,590.
Buffeted by higher energy prices, the gold-mining group as a whole is suffering from higher operating costs. This year, Newmont is targeting an average cost of production of $650 an ounce, up from $591 in 2011. But Newmont CEO Richard O'Brien says, "We're going to continue to focus on bringing down the total cost of the business over the next couple of years."
O'Brien is also focused on expanding operations in North America, as the political risk in finding new gold in the rest of the world is rising. To that end, Newmont acquired Fronteer Gold early last year for $2.3 billion, adding significantly to its gold assets in Nevada. Last year, 64% of production came from politically stable areas in the Asia-Pacific region, as well as North America. This year it will be closer to 75%.
"Newmont is an excellent way to leverage gold prices," says John Hathaway, manager of the Tocqueville Gold (TGLDX) fund, and a Newmont investor. Since 2004, when gold started trading freely through the SPDR Gold Trust (GLD) ETF, Hathaway points out that the price of gold has traded at five to 10 times the price of the index, the latter being where it is today. If the price ratio reverted to, say, 7.5, he says, the Philadelphia Gold & Silver index would rise 60%, based on $1,550 gold. If gold were to bounce back to $1,900, the index could nearly double.
One way to play this disparity is through the Market Vectors Gold Miners (GDX) ETF which recently fetched $43.01. There is no ETF based on the Philadelphia Gold & Silver index.
Barbara Marcin, a portfolio manager at Gamco Investors, thinks Newmont is a better bet, based on its scale and its low valuation. And she notes that production issues are already priced in. At 13 times 2013 estimates -- Newmont's five-year average P/E is 18 -- the stock would be worth $70.
Newmont Mining's large scale makes it an attractive way to play the record-low valuations of gold mining stocks. Shares could top $70 in a year.
Not all investors are convinced that gold has nowhere to go but up. Commodities investor Jim Rogers thinks gold could fall even further as stock markets pressure investors to sell gold to raise cash. And Daniel Gschwend, of Swiss asset manager Diem Client Partner, says Newmont's capital allocation has been less than ideal, though he is "fundamentally bullish" on physical gold.
But Marcin maintains that Newmont's shares will get a boost once the company starts to produce more gold over the next year or two. That should be better than money in the bank for shareholders.
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