I began in the public investments business in 2000. So, like others who began in and around that time, gold has been an unavoidable topic of conversation throughout our investment careers. Round about 2002, I first became interested in the metal through my daily reading of Richard Russell, a long (long, long) time gold bug. At the time, there was a certain value investment flare to gold. It had been beaten up for 30 years, was essentially left for dead by the investment community and, in spite of this, was not going to go away.
Upon discovering a hybrid preferred stock of Freeport McMoRan (MMR) (this was well before the days of GLD) that paid a 4% or more yield (if my memory serves), whose yield and mandatory redemption were both tied to the price of gold and trading at a 20% discount to the spot price of the day, I jumped… and won!
I was very fortunate in the timing of the Freeport preferreds – call it dumb luck. Anyhow, as success breeds affinity for that which makes you successful, I began to peruse the other investables tied to gold. This had to be around 2004 or 2005 — and again there was no GLD – so the next obvious (and, really, only) candidates were the mining stocks. Now, being of a conservative persuasion, all my instincts pointed away from the junior explorer hole-in-the-ground-with-an-optimist-standing-over-it types and to the majors, namely Barrick and the revered Newmont Mining. And what did I discover about these businesses?
They were profitable but not steadily upwardly trending earners (i.e., some years were better than others with no discernible pattern), reasonably financed, reasonably diversified in their asset bases, and wildly overpriced! Again, my memory may be foggy, but I recall 30-50x earnings with yields below 1% being the offering at that time. I confess to nibbling a tick as I had become hopelessly enamored with — by this time — the steadily rising price of gold (as well as Richard Russell’s daily musing about it). I broke about even with this foray, which was more than I probably deserved.
Returning to the opening of this piece and fast forwarding to today, I recently read that the miners were a better deal than the actual metal so, as a believer that somewhere-around-current-level gold prices are here to stay (and, if anything, could go higher), I decided to revisit. And, to my surprise, here is what I found:
Newmont Mining (NEM) – P/E of 10.8x, yield of 2.8%, 17 years of reserves
Barrick (ABX) – 8.9x, 1.4%, 18 years
If we believe that the price of the commodity which will drive these companies’ earnings is stable and/or upwardly trending, then both Newmont and Barrick are investable based on the cash flows they are set to generate. It is true that their costs will rise, their main cost being energy, and their reinvestment opportunities will be more expensive going forward. However, the capable managements of both enterprises have a proven track record at managing operations and expanding their reserves profitably. In other words, the gold price is the 80%, the other stuff is the 20%.
This prompts the question: Where is the price of gold headed? Mr. Buffett has done a most rational number on the value of gold in his recent letter, and I have no dispute with it whatsoever. Gold really doesn’t do anything— its value is based on what the other guy will pay for it. That being said, it is quoted in dollars. I read, just yesterday in the WSJ, that Bernanke’s Federal Reserve bought up a stunning 61% of the Treasury issuance in 2011. Why? Because for those of us, including foreign governments, the appetite to lend simply does not match the national government’s ravenous desire to spend. And so the printing presses run and run a lot faster than gold is being dug out of the ground.
It is possible that the other guy may wake up and not covet gold as much as he did the day before but, given the profligacy of the U.S. government, I consider it doubtful. As such, the gold miners of 2012 are set to continue to make good money and, unlike 2004-05, are not expensive.
Eric Houssels is the co-founder and managing member of Houssels Capital Management, LLC, a money management firm based in Las Vegas, NV. The firm focuses on investments in the stocks of publicly-traded companies of all capitalizations that possess, preferably, significant earnings power or, alternatively, assets that can be (re)deployed to achieve significant earnings power and are trading at reasonable valuations. Houssels Capital Management was founded in 2000.