In today’s Wall Street Journal Jason Zweig makes a bold statement claiming gold mining stocks as being cheap (“Is Gold Cheap? Who Knows? But Gold Mining Stocks Are”). While denying any ability in valuing gold he argues gold companies are cheap at a P/E of 14.
Coming from the editor of the most recent edition of "The Intelligent Investor" I found this logic abominable. In today’s market a P/E of 14 is not even that impressive. Walmart sells for 11 and Wells Fargo at just over 9, so by his same logic those companies must be steals.
One of the companies Zweig mentioned was Barrick Gold (ABX), and it is currently trading at a price to earnings of around 14 or right around the average of the S&P 500 index. On further inspection of the company you will see some particular trends which don’t seem favorable. The first being operating and net margins in 2010 were the highest in 12 years and likely farther yet as I only went back to 1999 figures. Not surprisingly margins have trended up over the last 10 years as the price of gold has gone up.
Of additional concern was the company’s net loss and free cash flow loss in 2009. It was not a small loss, but a gaping $4.48 billion loss that would wipe out profits the company made collectively in 2008 and 2010. I don’t need to look for an explanation for the loss; solid businesses don’t have such catastrophic losses. Wells Fargo, which is the largest lender of home mortgages, still managed to squeeze out a profit in the worse possible mortgage environment for each of the last three years. If Barrick can’t sustain positive earnings in the best of times for gold producers, then you must wonder about the caliber of the business.
Zweig, however, does acknowledge the possibility of gold tumbling to $900. A fall of that magnitude would bring earnings crashing down. How probable that event is makes all the difference, but I would bet it’s not all that improbable. By contrast a bank such as Wells Fargo could get hit with a $10 billion lawsuit relating to mortgage servicing. The bank could see an exodus of its customers to credit unions.
Various other risks could manifest themselves. These risks though I can safely assume are highly improbable. Even if the bank were to be hit with a $10 billion lawsuit it would not be as catastrophic as a crash in gold prices to gold miners. If gold were to fall to $900 earnings would be impaired for years to come. By contrast a huge lawsuit would be shrugged off in a year by Wells Fargo and future earnings would return to normal. Casual examinations of stocks such as Zweig’s can prove quite costly. His idea of “cheapness” of stocks is also suspect.
Benjamin Graham, whom Zweig's column is referencing, has a much more narrow notion of cheapness, and a P/E of 14 is certainly north of his range. Though I enjoyed Zweig’s commentary in the 2003 edition of "The Intelligent Investor," his column certainly does not meet the same standard of reasoning.
Disclosure: Long WFC