In the turbulent times like the ones we might be about to witness, the attention of precious metals investors tends to be focused on metals themselves, in particular gold and silver. Greece seems to be in a pretty precarious position, with a referendum coming in on the acceptance of the terms extended by its creditors. In the whole discussion, gold is being mentioned as the traditional safe-haven asset. The discussion seems to be on whether gold will thrive on a possible Grexit, whether there will be an initial sell-off like back in 2008. In this discussion, the frequently overlooked part of the precious metals market is the array of mining stocks.
A couple months back, we wrote a piece on the possible advantages of gold stocks to precious metals investors. If you haven’t had the chance to read this article, we encourage you to do so – particularly the first part, in which we discuss what mining stocks are and what they might offer in terms of investment. One of the most important things about gold stocks is that they might offer leverage over gold, in the sense that they might move more than gold does. Let’s recall our comments from the mentioned article:
(…) Miners might offer leverage but not necessarily in the traditional sense of operating on more debt. The leverage here would be possibility to multiply gold’s returns. In simple terms, on average, it is possible that if gold moves 1% up, some miners will move more than 1% up, thereby offering a multiplication effect. In this setting, an investor looking for exposure to the gold market could try to magnify their returns by including selected gold stocks in their portfolio. The catch here is which stocks to choose. Some will have leverage over 1, they will magnify gold’s returns (but also losses), some will have leverage below 1, diminishing returns (but also losses). Moreover, this is not a stable situation. Stocks with most leverage can “lose” it over time and, conversely, stocks with low leverage might “gain” it over time. In other words, if we were to rank gold stocks based on their leverage, they would trade places over time.
Since miners might “gain” or “lose” leverage, it might be beneficial to keep track of how the situation evolves, which miners offer the biggest bang for the buck and what order of magnification we are actually writing about. Fortunately, this process can be automated, and we have done so by developing the Gold Stock Ranking. This tool that gathers data, processes it and calculates leverage in an automatic fashion. All you have to do is to click on a list and choose what kind of parameters you’re interested in. The result is a list of miners sorted by how well they track gold and how well they magnify gold’s returns.
There is no such thing as the “best” gold stock. It’s more or less like choosing a car – some people need a 4x4, some need a sports car. It depends on personal preferences. In the same way, the choice of gold stocks depends on your personal preferences and circumstances. As we don’t really know them, nothing here should be considered “investment advice” – our tools might help you in investment decisions but you still have to consider various factors and your personal situation.
For the purpose of this analysis, we assume that the person interested in gold stocks has low risk tolerance in the sense that they would like their stocks to track gold and would sell gold stocks if they underperformed gold. The other thing to consider is the length of the investment horizon. We will distinguish between holding periods shorter than 6 months and label them a short-term position. A longer time horizon will be considered a long-term position. The main difference here is that short-term positions are more inclined towards speculation and long-term positions are more driven by fundamental factors.
We’ll start off with a short-term horizon. Let’s take a look at the Gold Stock Ranking (as at June 30, 2015):
In the first column (“Ranking”) you see the place in the ranking. We limit our discussion to the 5 top stocks in the ranking but the Gold Stock Ranking itself computes all the values for 19 gold stocks of our choice.
The second column (“Symbol”) is the symbol (ticker) of a given company you will see on stock exchanges.
The third column (“Valuation”) shows you the valuation of the company relative to its “usual” value relative to gold (calculated according to our proprietary methodology). Positive values here mean that the stock might be overvalued relative to gold. By the same token, negative values might suggest that the company is undervalued relative to the yellow metal.
The forth column (“Exposure”) shows you how well the company performs as a proxy for gold. It is based on the R-squared (statistical measure) for the gold stock and gold and can be interpreted as how well the price of the gold stock might be explained by the price of gold. 100% is the maximum value here, 0% the minimum. Generally, values over 50% might be considered as relatively significant.
The fifth column (“Leverage”) should be familiar by now – this is the leverage relative to gold, as explained earlier in this article. In general, the higher the value in this column, the greater the leverage – the more the moves of the price of the gold stock have magnified the moves of the price of gold. A value above 1 means that the stock has, on average, outperformed gold, a value below 1 means that the stock has, on average, underperformed the yellow metal. A negative value shows that the stock has, on average, traded in the opposite direction than gold.
The above picture is only a snapshot of what you can see using our gold stock tool. The version you can use on our site is interactive, meaning that you can choose the parameters of your choice and you can hover the mouse cursor over various parts of the tool to get info on what each part shows you. So, you can use this article as a guide to how you can use the tool and then head over to our website and test it for yourself.
Now, let’s get down to the nitty-gritty and check what stocks ranked highest at the beginning of July 2015.
Randgold Resources (GOLD) takes the first place with exposure at over 90% and leverage above 1.5. To break this down, Randgold seems to move in the same direction as the price of gold (exposure) and magnifies gold’s gains (and losses; leverage), on average and based on past data. The Gold Stock Ranking sums this up: “Including GOLD [ticker for Randgold Resources] in your portfolio appears to be a good idea.” Rangold might be slightly overvalued according to our methodology, just over 3%, but the valuation doesn’t seem to be too big a concern – this is not an extreme position.
Royal Gold (RGLD) comes in second, with exposure over 80% and leverage slightly over 1. These results are less favorable than for Rangold, both in terms of exposure and leverage, but by no means very bad ones. The Gold Stock Ranking gives you a hint that “Purchasing RGLD might be useful for diversification purposes, but it seems that it’s not providing much advantage over investing in gold itself.” Royal Gold is not exactly a terrible gold stock by our criteria but not a terrific one either. One concern here is that Royal Gold seems to be overvalued relative to gold by over 25%. The tool also gives you info that you might consider switching to other stocks close in the ranking but less overvalued (or even undervalued) around price bottoms. Rangold, holding the first spot, seems like a better choice during such times.
Eldorado Gold (EGO) holds the third spot but with visibly worse exposure to gold than the two previous stocks. Exposure is still above 50% and leverage above 1 (and better than for Royal Gold), and the Gold Stock Ranking boils this down to the message that “Purchasing EGO might be useful for diversification purposes, but it seems that it’s not providing much advantage over investing in gold itself.” As Royal Gold before, Eldorado doesn’t seem to be unfavorable as such but it doesn’t quite shine. One positive thing about Eldorado is that it seems undervalued relative to gold. Also, its valuation seems to be quite an advantage over Royal Gold. In this sense, one might consider switching from Royal Gold to Eldorado around price bottoms.
The exposure and leverage values deteriorate for the remaining two stocks, and this might be a suggestion that they neither track gold relatively well, nor offer leverage. In fact, the Gold Stock Ranking suggests: “Purchasing [them] is not advised.”
The analysis of the short-term time horizon has allowed us to identify one stock with possibly favorable characteristics (Rangold) and two with less favorable but still worth considering for diversification purposes (Royal Gold and Eldorado).
We have considered short-term positions. Now let’s take a look at what the long-term picture suggests (as at June 30, 2015):
The second place is taken by Harmony Gold Mining Company (HMY). Harmony Gold has similar characteristics to AngloGold Ashanti here, with marginally lower exposure over 70% and slightly lower leverage under 5 but it might also be slightly undervalued instead of slightly overvalued. The Gold Stock Ranking suggests: “Including AU in your portfolio appears to be a very good idea.” Both AngloGold and Harmony Gold seem to be favorable. The difference between the valuations of the two doesn’t seem significant enough to consider switching between them at the bottoms.
Barrick Gold (ABX) comes in third with lower exposure and leverage values than the two previous stocks, but still relatively favorable. Our ranking suggests: “Including ABX in your portfolio appears to be a good idea.” Barrick Gold also offers a slightly more favorable valuation – it seems to be over 4% undervalued relative to gold. Barrick Gold might be the stock to look at when considering further diversification of one’s mining stock holdings.
Yamana Gold (AUY) is fourth and it seems interesting since it has relatively weak exposure, definitely lower than the previous choices but at the same time it has the highest leverage of all the stocks in the long-term ranking (not only of the five presented; leverage under 6) and it is undervalued, slightly more than 6% undervalued. The tool suggests: "Including AUY in your portfolio appears to be a good idea.”
The last place in our analysis is taken by Newcrest Mining (NCMGY), which has more favorable exposure to gold than Yamana Gold, but less favorable leverage (over 3). It is slightly undervalued and the tools still suggests: “Including NCMGY in your portfolio appears to be a good idea.”
Taking a look at both the short- and long-term tables, we reach a relatively surprising conclusion, compared with our previous results on gold stocks. The exposure to gold is more favorable for only two first stocks in the short-term table, but it drops off quickly to relatively unfavorable values. With a drop in exposure follows a visible shift downward in leverage. The exposure in the long-term is more consistent, dropping from as we go down in the table, but not as much as for the short-term positions. The leverage seems a lot more favorable for the long-term positions than for the short-term ones. The only parts where short-term positions seem to offer an advantage is the exposure for the top two stocks and the possible undervaluation but the undervaluation coincides with dropping exposure.
There seems to be a shift from the situation at the beginning of 2015. The tradeoff between more exposure for short-term positions and more leverage for long-term positions is less obvious that it was back then. Right now, there seem to be stocks that offer relatively much exposure, upward of 70% and favorable leverage levels on the order of 5. No stock in the long-term ranking is discouraged as an investment. As such, long-term positions might offer favorable characteristics if one is looking for leverage as defined in this article.
Please, be aware that no representation is being made that the particular gold stocks will enjoy the same levels of leverage and exposure to gold in the future. Mind that the relationship between leverage and exposure is not stable and might change over time.
In this article, we have discussed the top 5 gold stock picks according to the Gold Stock Ranking, our interactive tool. To get to know this tool, head over to our gold stock ranking page. You can adjust the parameters of the tool to your liking there. If your interest in miners extends to silver stocks, check out our Silver Stock Ranking.
As has been already mentioned, the relationships shown in the Gold Stock Ranking change over time. It’s best to monitor one’s portfolio and review the appropriateness of the positions. We can’t stress the importance of proper portfolio structuring and invite you to read our piece on gold and silver portfolio construction, to get to know our take on various parts of the precious metals portfolio.
If you enjoyed the above discussion of mining stocks and our analysis, we encourage you to stay up-to-date with our free articles and alerts - sign up for our gold mailing list today. It’s free and if you don’t like it, you can easily unsubscribe.
Sunshine Profits‘ Contributing Author
Gold Investment & Silver Investment at SunshineProfits.com
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All essays, research and information found above represent analyses and opinions of Mike McAra and Sunshine Profits' associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Mike McAra and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. McAra is not a Registered Securities Advisor. By reading Mike McAra’s reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Mike McAra, Sunshine Profits' employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.