BOSTON (TheStreet) -- Gold and silver have tagged nominal highs and the rally's catalyst remains firmly intact: Sovereign debt woes, in Europe and the U.S., increasingly resemble a no-win scenario. Extreme leverage by government entities has been satiated with austerity programs and liquidity solutions, with little or no work done to resolve the true issue of solvency. Greece and Portugal are suffering under unsustainable debt burdens, and Italy and Spain are the latest targets of bond-market vigilantes, who may soon turn to the U.S.As fear gains traction, it's wise to consider precious metal investments as a core portfolio holding. Among the greatest of fears is the contagion potential of eurozone defaults. With almost every bank in the eurozone carrying low-quality bonds, a restructuring --the technical term for default -- may plunge the global economy into an even more severe recession than in recent years. While investors continue to herd into theoretically risk-free Treasury bonds, informed investors such as Bill Gross have warned that the U.S. is, in fact, in a more precarious financial position than Greece as accounting for entitlement liabilities renders our national debt at $75 trillion, or even higher. Despite the bond guru's analysis, downgrade threats from every credible rating agency and a pending debt-ceiling breach (with no signs of political compromise), the 10-year Treasury yields a paltry 2.9%. Those who argue for efficient markets should consider the countless economic reasons to avoid Treasuries and then consider investor demand. Treasury appetite is purely psychological. If the debt crisis worsens, investors assume the U.S. is least likely to renege on its obligations. This isn't a quantitative methodology, nor is precious metals investment, but the correlation between fear and metals performance is established. Owning gold or silver is, in many ways, illogical. Despite the metals bulls arguments that the two commodities are "money," they, in fact, are not. U.S. retail outlets don't accept gold in exchange for goods, and a return to a so-called gold standard for fiat, or paper, currencies is extremely unlikely. Going further, the shiny metal has no economic utility -- it isn't required to make anything. It can't power a car or feed your family. (Silver has plenty of industrial applications, but it also is being bought based on the psychology of fear.) While the precious metals trend could quickly reverse, and it's counterintuitive to bandwagon top-performing investments, metals merit attention as debt dilemmas are unlikely to die.
Gold and silver stocks offer leverage to the precious metals market, with profit margins rising substantially when gold and silver prices do. The Direxion Daily Gold Miners Bull 2x ETF ( NUGT), which offers double daily exposure to the NYSE Arca Gold Miners Index, has jumped 37% in a month. The issue with leveraged ETFs such as these is that they reset daily, so they are best used as short-term trading vehicles, but this ETF may offer a worthy hedge for those who fear a prolonged selloff in stocks and bonds and ongoing economic turmoil. The unlevered, physically backed SPDR Gold Trust ( GLD) and iShares Silver Trust ( SLV) are also useful vehicles for those investors who are seeking metals exposure. Those looking for an individual security should investigate Royal Gold ( RGLD). It's a company that owns interests in mining operations, and its beauty is its operating structure. Since it invests in mines, but doesn't incur their operating expenses, it has largely mitigated many of the cost and concentration risks of the business while still offering enhanced exposure to the metal through margin expansion. Royal Gold's stock has advanced 22% this year -- 18% in the past four weeks. It is scheduled to report fiscal fourth-quarter results Aug. 11. Last quarter, its gross and operating margins widened to 93% and 57%, both ranking in the 99th industry percentile. Royal Gold gets lackluster reviews from analysts, with four "buy" calls, three "hold" recommendations and one "sell" rating. Researchers, though, on average feel the stock is a bit undervalued. Royal Gold has a median price target of $72.04, implying a 12-month upside of 9.7%. RBC Capital Markets ( RY) and HSBC ( HBC) give the stock positive reviews. Wall Street forecasts that the company's fiscal fourth-quarter sales advanced 46%, past $59 million, and that adjusted earnings stretched 71%, to 39 cents. TheStreet Ratings ranks Royal Gold as the top U.S. metals and mining stock due to above-industry scores for growth, performance and financial strength. Royal Gold has grown sales and net income at annualized rates of 49% and 38%, respectively, since 2008. Its stock produced an annualized gain of 20% over that span. Royal Gold has $126 million of cash and equivalents on its balance sheet and $245 million of debt, for an ample quick ratio of 5.2 and a modest debt-to-equity ratio of 0.2. Last quarter's return on equity and return on assets, at 4.2% and 3.2%, respectively, need improvement. Also, the stock's valuation is rich at 35-times forward earnings and 29-times cash flow, but a PEG ratio (discounting predicted growth) of 0.4 signals a discount of up to 60% to long-run fair value. Royal Gold is a solid metals play.
-- Written by Jake Lynch in Boston.
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