After touching its 52-week low at the end of June ($1,180 per ounce), gold has rallied by 16%. That said, the metal is still down by 18% year to date. The rally in gold prices that started in August gained momentum from a combination of factors: (1) instability in emerging markets, (2) geopolitical unrest in the Middle East (Syria), which resulted in the rise of crude oil prices and (3) less conviction on the Federal Reserve (FED) starting its tapering in September. Despite the ongoing recovery in gold prices, the main question for investors should be: Is it still a good time to buy gold? I think not. Here I explain my reasons. Afterwards, I offer two alternatives if you still want to get some exposure to the yellow metal.
US Yield Should Keep Increasing Going Forward
Whether or not the FED's tapering starts in September, historically, yields are still on a low level. When rates go up, zero-yield investments such as gold, or its most popular ETF, the SPDR Gold Trust (GLD, Financial), start losing appeal. This is the main reason to explain why investors such as John Paulson or Steve Mandel have cut their long SPDR Gold Trust positions. It's easy to bet on a zero-yield instrument when there are no safe-haven alternatives available. Undoubtedly, when a 10-year U.S. treasury bond yields about 3%, gold loses its safe-haven appeal.
The Suit Theory
A few years ago, when I was reading George Soros' book “The Alchemy of Finance,” one pretty curios theory about gold's relative value took my attention. Soros, who has also been cutting his exposure to the SPDR Gold Trust, wrote that “one ounce of gold has historically been priced at par to a fine men suit.” This curious theory, which is actually pretty popular among gold investors, would indicate that gold is indeed still pretty expensive relatively to its historical price level. I bet you can find one good suit for less than $1,350, which is about the price you would pay for an ounce of gold as for today.
Alternative Investments
A good alternative for those looking for exposure to gold could be going long cheap gold producers that offer fair and sustainable cash dividend yields. My favorite companies in the sector are Barrick Gold (ABX, Financial) and Yamana Gold (AUY, Financial).
Barrick, which is held by Ray Dalio and its down by 45% year-to-date, trades at 2013 6.3 times P/E and 5 times EBITDA. Even when it pays a low 1% cash dividend yield, I think the prospects for the company are ameliorating fast. Its recent dividend cut and on-going cost reductions have improved financial flexibility making it possible for the company to finance its capex plans (such as the Pascua project) from internal cash flows. I think more asset sales are on the horizon in order to keep on reducing Barrick's relatively high net debt (at 2.2 times EBITDA). That said, I do like management's focus on free cash flow and its world-class resources. Barrick is one risky but potentially very profitable option.
On the other hand, Yamana Gold, which is held by Baupost's Seth Klarman, is a less leveraged (0.78 times 2013 EBITDA) growth story. Yamana's management has a great track record of turning around assets or divesting fast if the asset does not fit the company's cost structure. I expect the company to provide production growth towards the second half on 2013 and 2014. As a matter of fact, if gold prices stay at $1,350 an ounce, I expect Yamana to increase its top line by 10% between year over year. Yamana, which uses a $950 an ounce gold price estimate to measure reserves, trades at 91% net asset value versus its sector's average of 104%. In addition, the company offers a growing 2.35% cash dividend yield.
Conclusion
As U.S. yields go up, zero-yield investments become less attractive. Since I believe rates should keep on going up (although at a more moderate pace), I consider that gold is not going to be a great investment going forward. Nevertheless, if you still want some exposure to gold, there are fairly valued gold miners you could consider.
US Yield Should Keep Increasing Going Forward
Whether or not the FED's tapering starts in September, historically, yields are still on a low level. When rates go up, zero-yield investments such as gold, or its most popular ETF, the SPDR Gold Trust (GLD, Financial), start losing appeal. This is the main reason to explain why investors such as John Paulson or Steve Mandel have cut their long SPDR Gold Trust positions. It's easy to bet on a zero-yield instrument when there are no safe-haven alternatives available. Undoubtedly, when a 10-year U.S. treasury bond yields about 3%, gold loses its safe-haven appeal.
The Suit Theory
A few years ago, when I was reading George Soros' book “The Alchemy of Finance,” one pretty curios theory about gold's relative value took my attention. Soros, who has also been cutting his exposure to the SPDR Gold Trust, wrote that “one ounce of gold has historically been priced at par to a fine men suit.” This curious theory, which is actually pretty popular among gold investors, would indicate that gold is indeed still pretty expensive relatively to its historical price level. I bet you can find one good suit for less than $1,350, which is about the price you would pay for an ounce of gold as for today.
Alternative Investments
A good alternative for those looking for exposure to gold could be going long cheap gold producers that offer fair and sustainable cash dividend yields. My favorite companies in the sector are Barrick Gold (ABX, Financial) and Yamana Gold (AUY, Financial).
Barrick, which is held by Ray Dalio and its down by 45% year-to-date, trades at 2013 6.3 times P/E and 5 times EBITDA. Even when it pays a low 1% cash dividend yield, I think the prospects for the company are ameliorating fast. Its recent dividend cut and on-going cost reductions have improved financial flexibility making it possible for the company to finance its capex plans (such as the Pascua project) from internal cash flows. I think more asset sales are on the horizon in order to keep on reducing Barrick's relatively high net debt (at 2.2 times EBITDA). That said, I do like management's focus on free cash flow and its world-class resources. Barrick is one risky but potentially very profitable option.
On the other hand, Yamana Gold, which is held by Baupost's Seth Klarman, is a less leveraged (0.78 times 2013 EBITDA) growth story. Yamana's management has a great track record of turning around assets or divesting fast if the asset does not fit the company's cost structure. I expect the company to provide production growth towards the second half on 2013 and 2014. As a matter of fact, if gold prices stay at $1,350 an ounce, I expect Yamana to increase its top line by 10% between year over year. Yamana, which uses a $950 an ounce gold price estimate to measure reserves, trades at 91% net asset value versus its sector's average of 104%. In addition, the company offers a growing 2.35% cash dividend yield.
Conclusion
As U.S. yields go up, zero-yield investments become less attractive. Since I believe rates should keep on going up (although at a more moderate pace), I consider that gold is not going to be a great investment going forward. Nevertheless, if you still want some exposure to gold, there are fairly valued gold miners you could consider.
