By Martin Hutchinson Director of Global Investing Research
[Editors Note: The Second of Two Parts. To Read Part I of this story, please click here].
If you were a gold investor back in the good old days of 1895, life was pretty easy. You'd spend the day in a huge leather armchair at your London club, sipping fine brandy. Periodically, a servant would telegraph buy-and-sell orders to your broker as you played the "Kaffir" gold-share-boom of that year.
You would avoid political risk by investing only in gold mines located in British colonies. And you wouldn't worry about the price of gold, either - it was 3 pounds 17 shillings and 10 pence an ounce - and had been since Britain went back on the Gold Standard in 1819.
Back then, you had but two worries. First, did the mine contain any gold (engineers' reports were crucially important)? Second, was the mine developer such an out-and-out crook that none of the profits would reach you?
It was a very simple business model. The price of gold was the price of gold, the mining cost was the mining cost, and if the difference between the two was positive, profits would flow into your pocket.
Today, of course, it's quite a bit different. Modern finance has intervened with long-term futures and options contracts.
As a result, we still know the market price of gold, but we don't know the price at which gold mining companies are selling their gold!
For example, gold miner AngloGold Ashanti Ltd. (AU) has recently "sold forward" three years of its gold mine output for a set price of $600 an ounce, regardless that the market price is now ranging upwards of $750.
This process is known as "hedging." And I understand why gold miners do this. The executives want to make sure their jobs, and the jobs of its miners, are secure - even during a gold-market downturn.
However, investors don't care much about preserving the jobs of gold miners, let alone those of mining company executives. We want to know what we're getting in the form of earnings and dividends - and we want to benefit from a rise in gold prices.
The bottom line is that to invest in gold mines today, one must read a lot of boring and incomprehensible accounting footnotes - and must hope that the mining company isn't in a jurisdiction where they don't need to disclose the facts those footnotes usually contain. We're also fortunate that hedging - very fashionable a few years ago - has decreased in use as gold prices have soared.
And gold prices are projected to keep rising. So let's take a look at the world's largest gold mining outfits that U.S. investors can easily buy into, either directly, or through American Depository Receipts (ADRs).
Of course, for the highly risk-averse investor who still wants to invest in gold, the simplest strategy is to buy an exchange-traded fund, or ETF. The StreetTracks Gold Shares Trust ETF (GLD) invests in gold directly and is a good bet.
But for Money Morning readers looking for higher potential returns, here's a look at the major players, along with my five "best bet" recommendations:
Royal Gold Inc. (RGLD) is a U.S.-based company, with operations in Nevada, Mexico and Argentina. The political risk is low. But with a market capitalization of $930 million, a trailing P/E of 41, and a forward P/E 35, this stock looks expensive.
Having taken this tour of the global gold-mining industry, and having evaluated the key players, the best values appear to be:
#1: Barrick (ABX). #2: Yamana (AUY).
#3: AngloGold (AU) (an attractive play if you don't mind its excessive hedging and South African political risk).
#4: Newmont (NEM).
#5: Kinross (KGC) would be my final choice.
And, of course, don't forget the bonus: the Gold Shares ETF (GLD).
News and Related Story Links: