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Gold Stocks Ready for a Recovery

Editor's note: As part of our partnership with PBS's Nightly Business Report, TheStreet's Alix Steel will appear on NBR Tuesday (check local listings) to explain why some analysts say gold mining stocks are attractively undervalued.

NEW YORK (TheStreet ) -- As markets are slammed with volatility and fears of a double-dip recession persist, gold stocks are poised to prove themselves as a moderately safe place to stash cash.

Gold stocks can, no doubt, be volatile, as they are subject to geopolitical issues and a constantly churning gold price. That said, many analysts believe the gold sector is undervalued and poised for a comeback.

Gold miners have had a hard time providing the expected leverage of 2:1 or even 3:1 vs. the price of bullion. Since the end of 2008 the gold price has rallied more than 73.5%, but the Market Vectors Gold Miners (GDX) is up just 56%. The crème de la crème of gold stocks, Barrick Gold (ABX), rallied a meager 18.9% while growth stocks like Randgold (GOLD) added 83.3%. More speculative plays like NovaGold (NG) jumped 514.2%, but even that kind of dramatic leverage is dissipating.

Word on the Street

The biggest catalyst for this shift has been the emergence of physically backed ETFs. The first and largest, SPDR Gold Shares (GLD), was launched in November 2004, and was followed by three more. Since inception, the GLD has amassed more than 1,300 tons and currently holds 1,209 tons. The ETF buys gold, which helps support the gold price, but it also gives investors an easier way of buying into the market without the associated risk of miners.

There are two principal negatives often associated with miners -- risk and cash flow. In certain countries, like Peru and Bolivia, governments have been talking about raising taxes on miners or even nationalizing the mines to take advantage of high gold prices. Either move could seriously dent profits and reserve and resource bases for miners. Investors "are like scared rabbits," says Steve Ayer, managing director and partner at High Tower's Strata Wealth Management.



Peru, for example, elected a nationalist president, Ollanta Humala, on June 15. Humala favors high mining taxes to return money to the Peruvians and there is speculation that he may go so far as to nationalize mines. Ayer believes that the president isn't going to come into office and change all the economic policies, especially because Peru has the highest growth rate of any nation in South America, according to his calculations. "What they have in place is working ... [they are] not going to break the mining stocks." Even if it doesn't happen, the threat of nationalization is enough to scare investors out of a gold stock and into a gold ETF.

Mining gold is also expensive and risky. Companies could not find enough gold, it might take longer for the gold to be pulled out of the ground, production might be halted for myriad reasons and all of that costs money. The average total cost to produce an ounce of gold for the industry is currently between $750-$1,100, only made worse by high oil prices, which jack up input costs.

Another less recognized factor weighing on the gold stocks that Leo Larkin, equity analyst at Standard & Poor's, points out is that over that the last 10 years gold companies had to issue huge amounts of shares in order to raise cash to build mines. This dilution is taking a while to shake out of the share price.

"Between 2001 and 2010, Barrick has increased shares outstanding by 86%. That's overlooked when people try to come up as to why these stocks are lagging." Larkin has a strong buy rating on Barrick, however, believing that it is done issuing shares pointing to its recent acquisition of Equinox, which was paid for in cash. "You could say the risk/reward is more favorable now than before because the stocks haven't moved and we think they can provide this leverage."

TD Newcrest is also bullish on gold stocks with its top picks being Goldcorp (GG), Eldorado Gold (EGO) and Iamgold (IAG). "Gold equities, on the back of rising gold prices, have generated the best forward earnings growth since mid-2007 at 195%," TD Newcrest said in a recent research note, "yet the average forward P/E multiple has contracted 45%," meaning that the markets expect lower earnings growth.

Stock quotes in this article: GDX, GLD, ABX, GOLD, NG, SLW, GG, EGO, IAG, AXU 

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