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Which Is Better: Gold Or Gold Stocks?

November 10, 2011 by  

Which Is Better: Gold Or Gold Stocks?

“The impact of the rate of inflation on the price of gold is like tracking the footprints of an animal.”  — Julian M. Snyder (quoted in The Maxims of Wall Street by Mark Skousen)

The Midas metal has been on a tear since 2001. Since then, the world has witnessed two major stock market collapses, a boom-bust in real estate, the Great Recession and a European debt crisis. Throughout it all, gold has increased from $300 an ounce to nearly $2,000, before retreating (it currently is around $1,750 an ounce).

Above all, remember that political and economic crises mean more government and more inflation. The central banks have been busy printing a lot of new dollars, euros and yen since 2001. It was clearly catch-up time for commodities in general and the precious metals in particular.

Gold Is Now A Superior Inflation Hedge

What have we learned about gold? First, gold has maintained its purchasing power for centuries. Business professor Roy Jastram did the original research on this fact in The Golden Constant. The following chart demonstrates this fact:


Source: www.thechartstore.comWhat’s interesting is how gold has broken out on the upside of its long-term purchasing power ever since 1971, when the United States and the world went off of the gold standard.

Gold is now a superior inflation hedge by a considerable margin, especially if you buy it when it’s cheap (1971, 2001).

It always was said that a $20 Saint-Gaudens double eagle gold coin could buy a tailor-made suit in New York in the 1920s. Today, at $1,750 an ounce, you can buy three tailor-made suits.

The same holds true for the silver dollar. In 1960, a silver dollar was worth $1 in paper dollars. Today, it costs $38.

However, it also is important to remember that since going off of the gold standard, precious metals prices are volatile. Gold went through a 20-year bear market from 1980 to 2000.

What About Gold Stocks?

If you thought gold was volatile, gold mining stocks are even more so. Typically, in a bull market, if gold doubles in price, you would expect gold mining stocks to triple or quadruple in price.

However, recently (see the preceding chart), just the opposite has happened. Gold bullion (GLD) has risen sharply, and the gold stocks (GDX) have failed to keep up.

What gives?

To find out, I called the world’s expert on mining stocks, Rick Rule. Rule is president of Global Resource Investments, a brokerage firm specializing in natural resources that is wholly owned by Sprott Inc., one of the world’s preeminent natural resource investment firms. I’ve known Rule for more than 30 years as a friend and as a valuable adviser.

Five Reasons Why Mining Stocks Have Lagged

Rule offers five reasons for this disparity:

  1. The introduction of the gold exchange-traded fund (GLD) has made it easier for investors to invest in pure gold. Before GLD was available, investors had to buy physical gold through coin dealers or foreign banks.
  2. Gold equities anticipated the run up in gold prices five years ago, and the metal had to “catch up” to expectations already built in to the equity markets.
  3. Mining companies have disappointed investors; they have failed to perform in increasing free cash flow and profitability, relative to the rapid rises in commodity prices. Rule blames this lack of leadership on the 20-year bear market in gold (1980 to 2000); the best managers went to more profitable opportunities (high technology, etc.).
  4. The mining industry has gone through its own version of inflation, through share dilution. Market capitalization has risen much faster than share prices, as companies have resorted to issuing new stock to raise capital. (We’re seeing this share dilution especially in the “rare earth” and “uranium” stocks in the past few years.)
  5. Up to 90 percent of all junior mining companies — all heavily diluted — are “no good,” according to Rule, and investors are heavily discounting their value.

Why The Gold Market Is About To Change

But Rule has good news. While the competition with gold and silver exchange-traded funds will continue, mining companies are now inexpensive relative to bullion. Investors will be rewarded accordingly.

Here are the reasons why mining stocks are about to soar in the next few years:

  1. After a 10-year bull market, good managers have returned to the mining sector.
  2. Top mining companies are generating dramatically higher profit margins. Free cash flow is now “gushing” and will double in the next year as huge capital investments by the major mining companies paid off.
  3. Expect enormous consolidation as major mining companies start buying up smaller producers at startling premiums to current market prices.
  4. New discoveries are expected as 10 years of exploration pay off. The gains accruing to successful exploration efforts can be explosive.

Where To Invest

Rule is constrained by regulation from making recommendations, but his clients report a fondness for Barrick Gold, Goldcorp and Kinross, among the majors; Royal Gold and Franco Nevada among the royalty companies; Perseus, Lydian and Esperanza among the developmental juniors; and Vista Gold as an undervalued takeover target. I also like IAMGOLD (IAG).

And if you like to hedge your bets and earn a dividend yield of more than 10 percent while you wait for mining stocks to go up, consider investing in the Gabelli Gold and Natural Resource Income Fund (symbol GGN).

–Mark Skousen
Editor, Forecasts & Strategies
www.markskousen.com

Mark Skousen

, Ph. D., is a professional economist, investment expert, university professor, and author of more than 25 books. He earned his Ph. D. in monetary economics at George Washington University in 1977. He currently holds the Benjamin Franklin Chair of Management at Grantham University. He has taught economics and finance at Columbia Business School, Columbia University, Barnard College, Mercy College and Rollins College. He also has been a consultant to IBM, Hutchinson Technology and other Fortune 500 companies. Since 1980, Skousen has been editor in chief of Forecasts & Strategies, a popular award-winning investment newsletter. He also is editor of three trading services, Skousen Hedge Fund Trader; Skousen High-Income Alert and Turnaround Trader. In 1995, he served as editor of the investment series, "Secrets of the Great Investors," with Louis Rukeyser as narrator. He is a former analyst for the Central Intelligence Agency, a columnist to Forbes magazine (1997-2001), and past president of the Foundation for Economic Education (FEE) in New York. He has written articles for The Wall Street Journal, Liberty, Reason, Human Events, the Daily Caller, Christian Science Monitor and The Journal of Economic Perspectives. He has appeared on ABC News, CNBC Power Lunch, CNN, Fox News and C-SPAN Book TV. In 2008-09, he was a regular contributor to Larry Kudlow & Co. on CNBC. His economic bestsellers include "Economics on Trial" (Irwin, 1991), "Puzzles and Paradoxes on Economics" (Edward Elgar, 1997), "The Making of Modern Economics" (M. E. Sharpe, 2001, 2009), "The Big Three in Economics" (M. E. Sharpe, 2007), "EconoPower" (Wiley, 2008) and "Economic Logic" (2000, 2010). In 2009, "The Making of Modern Economics" won the Choice Book Award for Outstanding Academic Title. His financial bestsellers include "The Complete Guide to Financial Privacy" (Simon & Schuster, 1983), "High Finance on a Low Budget" (Bantam, 1981), co-authored with his wife Jo Ann, "Scrooge Investing" (Little Brown, 1995; McGraw Hill, 1999), and "Investing in One Lesson" (Regnery, 2007). In 2006, he compiled and edited "The Completed Autobiography, by Benjamin Franklin (Regnery)." In honor of his work in economics, finance and management, Grantham University renamed its business school, "The Mark Skousen School of Business." Dr. Skousen has lived in eight nations and traveled and lectured throughout the United States and 70 countries. He grew up in Portland, Ore. He and his wife, Jo Ann, and five children have lived in Washington, D.C.; Nassau, the Bahamas; London, England; Orlando, Fla.; and New York.

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