S&P goes for the gold: 5 reasons to buy

In a review of the gold sector, Standard & Poor's looks at 2 ETFs, 3 stocks and 5 reasons to invest in the precious metal.

By TheStockAdvisors Mar 20, 2012 1:14PM
Image: Small Stack of gold ingots (© Anthony Bradshaw/Photographer)By Leo Larkin, S&P Capital IQ Equity Analyst, The Outlook

S&P Capital IQ has a positive outlook for gold and gold-related investments for 2012.

Even though the price of gold has risen steadily over the past decade --  reaching its highest average level ever in 2011 -- we believe gold will continue to climb in 2012 for five reasons. We also look at a trio of gold stocks and two exchange-traded funds.

First, the Federal Reserve is committed to keeping short-term interest rates near zero through 2014, so we see no opportunity cost for buying and holding gold anytime soon. Low short-term interest rates reduce the opportunity cost of owning gold.

Second, despite higher gold prices, global mine production has been stagnant for more than a decade.

According to data compiled by Gold Fields Minerals Service, a U.K.-based metals consulting firm, global mine output of gold totaled 2,809 tons in 2011, only 8% more than the 2,602 tons mined 1999.

We believe production will be stagnant for the next several years as well, as old mines are becoming depleted and not being replaced to the extent needed to significantly lift output.

Third, we expect that greater volatility in the world's major currencies will increase demand for gold as a monetary reserve asset. China and other countries that hold a large portion of their foreign exchange reserves in U.S. dollars will ultimately diversify their assets out of the dollar and into gold. We expect that gold will rise in all currencies due to the implementation of quantitative easing policies by central banks worldwide.

Fourth, we think that gold demand will benefit from ever-increasing concerns about the credit quality of international sovereign debt. In our view, the threat of sovereign debt defaults increases the appeal of gold as a safe haven.

Finally, we believe that strong growth in the U.S. monetary base and the M-2 money supply will provide the catalyst for a further rise in the price of gold later this year due to increased concerns regarding inflation.

The monetary base rose by 29% in 2011, while the M-2 money supply expanded by 9.4%. More recently, the monetary base was up 23.3% year-over-year through Feb. 24, while the M-2 money supply was up 10.2% year-over-year through Feb. 13.

Based on our expectation for a further rise in the gold price in 2012, we look for another sizable gain in earnings for the three gold companies that we follow: Randgold Resources (GOLD), Newmont Mining (NEM) and Barrick Gold (ABX).

As a group, we forecast earnings-per-share growth of 40% in 2012 over 2011, with the bulk of the projected gains coming from Randgold. Aggregate earnings for this group soared 57% in 2011.

Following a 10% rise in 2011, to $1,564 per ounce, and a 13% advance through late February, we believe that gold will trade in a sideways pattern for the balance of 2012, before ending the year at $1,900 per ounce, up about 21%.

For investors seeking to own gold stocks through an exchange-traded fund (ETF), we think one of the best ways is through the Market Vectors Gold Miners (GDX).

The fund holds 31 gold and silver stocks in its portfolio, including three covered by S&P Capital IQ equity analysts. The holdings in GDX are a blend of large-cap, more slowly growing senior gold producers and faster-growing, mid-cap and small-cap producers.

Investors interested in a more aggressive approach to gold stocks might consider the Market Vectors Junior Gold Miners (GDXJ). The fund has assets of $2.5 billion. Its holdings consist of 81 small and medium-cap gold and silver mining companies.

In contrast to the more established producing companies in GDX, many of the companies held by GDXJ are early-stage exploration companies with little or no production and limited access to financing.

Consequently, this ETF tends to be more volatile and could be especially vulnerable to a downturn in the gold price, in our view.

At the same time, GDXJ would be expected to outperform GDX in a rapidly rising gold price environment, by our analysis.

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6Comments
Mar 20, 2012 4:39PM
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First, the Federal Reserve is committed to keeping short-term interest rates near zero through 2014, so we see no opportunity cost for buying and holding gold anytime soon. Low short-term interest rates reduce the opportunity cost of owning gold.

Really. Voting members seem to indicate otherwise. They just have to get a majority to raise rates, I don't think inflation will allow rates to remain low like this in the coming years.

Second, despite higher gold prices, global mine production has been stagnant for more than a decade.

Read some 10k reports from the gold producers. Every indication is increased production.

Third, we expect that greater volatility in the world's major currencies will increase demand for gold as a monetary reserve asset. China and other countries that hold a large portion of their foreign exchange reserves in U.S. dollars will ultimately diversify their assets out of the dollar and into gold. We expect that gold will rise in all currencies due to the implementation of quantitative easing policies by central banks worldwide.

This I can see. But this could become a turning point down that line that ultimately crushes gold.

Fourth, we think that gold demand will benefit from ever-increasing concerns about the credit quality of international sovereign debt. In our view, the threat of sovereign debt defaults increases the appeal of gold as a safe haven.

Only if they don't actually happen.

 

In the event of actual defaults, investors will sell off gold instruments (ETFs) and futures which dominate the physical price. It won't matter that people would like to physically hold gold.

 

The only reason gold bounced back in 2008 was massive injection from the Federal Reserve and public bailout money inflating the money supply. You might recall it actually dropped 30% when the market turned down.

 

In actual soveriegn defaults, gold holdings will be sold to raise cash.

Finally, we believe that strong growth in the U.S. monetary base and the M-2 money supply will provide the catalyst for a further rise in the price of gold later this year due to increased concerns regarding inflation.

In the near to intermediate term, yeah, I'd say gold could rise if inflation gets hot enough. I think in the very long view, it collapses.

Mar 21, 2012 12:00PM
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Don't buy gold. Buy stocks.

No one needs hard assets. The system can never fail.

Trust Obama, Bernanke, Paulson, Soros, and Geitner.

They will protect you....

and pay no attention to the man behind the curtain.

Mar 20, 2012 10:35PM
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Same old TIRED story from the gold pushers.
Mar 20, 2012 7:20PM
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Stromprophet; whether it collapses or not will depend on how high it goes up between now and said collapse.  Based on the increase in the money supply and the increase in the cost to extract gold I don't think we are in bubble area yet.  In order to collapse gold would have to go below the cost of extracting, and that would not last for long. 

 

"Everyone" was buying tech stocks in the late 90's and those same people were "all" buying real estate in 2005 and 2006 but "everyone" was not jumping into gold in 2011.  It is typical in a bubble for it to appear over before hitting the biggest period of being inflated and when it pops it explodes a big chunk, more people get in on the "buying opportunity" and then it re-inflates near to where it was at the peak and then it collapses.  If this is to become a bubble it has not yet entered into the phase of being owned by "everyone".  Bubble or not, it has gone up and it is a volatile commodity so it can go down significantly.  I just don't think it is in a position to "collapse" as it would if it became a bubble.

Mar 20, 2012 7:43PM
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Just a hedge, designed for a greater fool to buy at above your cost.
Mar 21, 2012 4:26PM
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Cheap money is here and only hard assets will keep its value.  Smile
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