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:
Barrick Gold Corp. (ABX) is a Canadian company with mostly North American production. It has some operations in South America and Africa, and mines copper and zinc, as well as gold. It has a $36 billion market cap, so there's plenty of liquidity. The shares are trading at a trailing P/E of 34 (on the last 12 months' earnings), but a forward P/E (on next 12 months' profits) of 20. The company has eliminated its forward hedging program. By gold mining standards, this company is substantial in both size and scope, is reasonably valued, and features very little political risk.
Agnico-Eagle Mines Ltd. (AEM) operates a gold mine in Northeastern Quebec, so there's no political risk - unless Quebec separatism worries you. $7 billion market capitalization. Trailing P/E 46, forward P/E 44. You can pay too much for a nice location.
AngloGold Ashanti Ltd (AU) is a South African company with operations in Argentina, Australia, Brazil, South Africa and West Africa. It has a market cap of $12 billion, a trailing P/E of 34, and a forward P/E of only 17. The good news: I like the diversification. And with its medium political risk, it's reasonably priced based on next year's projected earnings. The bad news: It has sold forward three years worth of production at a contract price of $600 an ounce. These contracts already have a value of minus $2 billion, and that negative value will increase as the price of gold rises. Stupid people, but bear in mind that this company's earnings will jump if they ever manage to get rid of the hedges.
Yamana Gold Inc. (AUY) is a Canadian company with operations in Brazil, Argentina, Chile, Honduras and Nicaragua. It is spending the equivalent of $3.8 billion in cash and stock to take over Meridien Gold Inc. (MDG), which has operations in Chile, Mexico and the United States. Yamana's market cap is $5 billion, and its shares trade at a trailing P/E of 64, but a forward P/E of only 13. There's a middling political risk, and a bit of an added business risk, due to the Meridien takeover. Investors can look forward to production doubling to 2.2 million ounces per year by 2012, primarily in Brazil and Argentina. I like this one, too, though the added risk of the Meridien acquisition should be kept in mind.
Gold Fields Ltd. (GFI) is a South African company with mining operations in South Africa, Ghana, Australia and Venezuela (of which they just sold control to a local company). The company has a market cap of $12 billion, a trailing P/E 31, and a forward P/E 20. Upper-medium political risk, depending on what you think of South Africa. My view is that South Africa is acceptable currently, but there's a good chance of Jacob Zuma winning the Presidency in April 2009, and he's a nasty anti-Western leftist with a criminal record. On the other hand, that's 18 months away, and the gold surge will probably have played out by then. GFI doesn't hedge the gold price, which is a plus.
RandGold Resources Ltd. (GOLD) is an offshore British company that mines in Africa (but not South Africa). The political risk is medium-high. With a market cap of $2.4 billion, a trailing P/E of 62 and a forward P/E of 31, this stock is expensive, especially given the elevated political risk.
Harmony Gold Mining Co. Ltd. (HMY) is a South African company, with gold, copper and uranium mines, and operations in South Africa, Australia and Papua New Guinea. There's only a medium-level political risk here. The company has a market cap of $3.8 billion, and the shares feature a trailing P/E of 79 and a forward P/E of only 17. The company does not appear to hedge, but that's not a statement I can make with certainty. This miner has made some losses in recent quarters (theoretically, very tough to do at current gold prices). Given the losses, I'd have to regard this one as overpriced.
IAMGOLD Corp. (IAG) is a Canadian company that mines primarily in Canada, Surinam, Ghana and Mali. Despite some of those exotic-sounding locales, the political risk is low-to-medium. The company has a market cap of about $2.4 billion. Though the shares trade at a forward P/E of about 22, the company has a trailing loss. Given that loss, the shares should be considered expensive.
Kinross Gold Corp. (KGC) is a Canadian gold-and-silver miner, with primary operations company in Canada, the United States, Brazil, Chile and Russia. Kinross issued shares to buy a large Brazilian/Russian company in February. The market cap is big at $10 billion, the political risk is low to medium and the company doesn't appear to hedge. However, with a trailing P/E of 35 and a forward P/E of 24, the shares appear a bit on the expensive side.
Lihir Gold Ltd. (LIHR), a Papua New Guinea-based company, operates in PNG and explores in Australia. Given that some PNG miners have had some problems, there's a mid-level political risk here. And with a market cap of $7 billion, a trailing loss, and a forward P/E of 29, this stock looks overpriced, too.
Newmont Mining (NEM) is one of the better-known miners, based in the United States and operating in the U.S., Australia, Peru, Indonesia, Ghana, Canada, Bolivia, New Zealand, and Mexico markets. The political risk is low. It has a market cap of $21 billion, a trailing loss and a forward P/E of 26. Newmont used to hedge, selling gold at $384 an ounce, but closed out its positions, took the loss (from the contracts as well as losses related to a fatal accident at its Midas mine in Nevada) and now operates un-hedged. Not a bad value, but Barrack looks better.
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: