We believe that gold is money. It is easily transferable and easily transportable. It is a currency, which unlike paper or electronic money, cannot be created at will. Gold, unlike other currencies is not replicable.
When the Federal Reserve engages in "Quantitative Easing," it buys assets like Treasuries or mortgage backed securities. It buys these assets with money that it creates at will. The dollar amount of assets which the Fed holds on its balance sheet is equivalent to the amount of dollars it has printed. In fact, Mr. Bernanke stated in a speech made in 2002: "U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes…" When more money is created and supplied to the monetary system, this money in theory becomes worth less.
Worthless relative to what? Worthless relative to gold, a currency which cannot be printed or created at will. Additional money printing should be a positive for gold. The lack of increased money printing may be bad for gold. Why has the Fed printed money at a prodigious rate since 2008? Ostensibly it has done so to fulfill one part of its dual mandate, namely "maximum employment." Has this mandate been met? Will it be met without additional monetary stimulus in the form of money creation?
Like Richard Fisher, the president of the Federal Reserve Bank of Dallas, and nonvoting member of the Federal Open Market Committee said, "if the US economy is able to grow to the degree that more people are employed, then more money creation will most likely not be necessary." If not, then perhaps we could see more money creation in the future.
The United States is not the only country which is creating money at a rapid rate. Different central banks have different mandates, but the reality of the situation is that many economies desiring to grow at a faster rate have created money as well. In an environment where these economies can't grow their way out of economic doldrums, more money creation is likely. More supply of money of any kind makes gold, the one non-replicable currency, continually more valuable.
It seems as if many investors have capitulated on the gold stocks, and prospective investors will not even consider buying a gold mining company as a means of investing in gold. In fact, we have been in group meetings with managements of gold mining companies in which generalist investors have sat through the entire meeting and then simply asked at the end of it: "why should I ever buy a gold stock if they consistently underperform and do not correlate completely with the gold price?"
These two charts below will answer that question. The first chart represents growth in earnings per share for the first three quarters of 2011 for the seven largest US listed gold companies, and the second chart shows growth in dividends per share for the past three years.
We believe that if the gold price stays at $1600 per ounce (or even declines by over 10% to around $1400 per ounce) earnings per share and dividends per share growth will continue. Should the price of gold increase, the rate of growth in earnings and dividends will be significant.
What is driving the growth, and why should dividends increase? No established company in the gold mining industry is currently "ex-growth." For better or for worse, the industry has been and continues to be focused on building bigger companies. Projects that began construction more than two years ago are currently in various stages of development, with many projects slated for completion over the next three years. In terms of dividends, we estimate that dividend payout ratios for most companies will remain well below 30% in 2012 given a $1600 per ounce gold price, and that gold companies will continue to increase dividend payouts as income starved investors demand a higher current return. We also believe that the gold miners are relatively cheap, with the larger, slower growth companies such as Barrick (ABX) and Newmont (NEM) trading at 8x and 10x 2012 projected earnings per share respectively given $1600 per ounce gold.
In response to questions that we have heard from market participants relative to why anyone would ever want to own a gold stock, our response is simple: Would you like to own a cheap company with earnings and dividend growth, which gives you exposure to a non-correlated asset class? In addition, would you like to buy this gold in the ground at a significant discount to the spot price? If the answer to these questions is "yes," then maybe you should give gold stocks a good look.