Sell Gold, Bonds, and the Gold Miners

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I don’t know about you, but I think we can all agree that gold has been an awful investment lately. It went from being coveted treasure to the atomic bomb. The gold community is busily debating over whether or not gold is over-valued, under-valued, a buy, or a sell, and etc.

The buy gold thesis

Tom Luongo from Seeking Alpha recently released an article, and in it he stated:

If there is one thing I've learned in my years of watching over the gold and equity markets since Ben Bernanke took over as Chairman of the FOMC it is to ignore nearly everything said and focus on the reaction by the markets. Wednesday's statement contained nothing at all worth remembering no less reacting to but the markets have reacted badly to this nothingness as if it is the end of the Fed's coming to its rescue. So, what does this mean for gold? In the short term, it means that there will be more volatility, possibly more action to the downside. Why? Because there is a growing lack of liquidity in the markets and gold is always sold during liquidity stress, which is why buying now is the right play.

Okay, so this is the boldest argument for why someone should attempt to purchase gold. To summarize, the Federal Reserve may not exert that much downwards pressure on the commodity because the volatility in equity markets will cause investors to flee into gold, or bond investors may eventually pick up the commodity as an alternative to safety.

But here's what's wrong with it

<img alt="" src="http://g.fool.com/editorial/images/55091/7-2-13-gld-pic-1_1_large.jpg" />

Source: GoldUnderCover

Commodities like gold and silver are perceived to be the riskiest of assets in a standard risk profile, only those who would be willing to take on the highest amount of risk would be vested in the gold market. So if market volatility were to hit, would not the assets that are perceived to be the riskiest be sold the quickest? Is not that what actually happened?

<img alt="" height="463" src="http://g.fool.com/editorial/images/55091/7-2-13-gld-pic-2_large.png" width="740" />

Source: Ycharts

The SPDR S&P 500 (NYSEMKT: SPY) seems to have outperformed gold, dollar, and bonds this year. Why? Because stocks are inflation hedged, and unlike bonds, stocks can be safe too, so as long as you buy the coupon-like securities (Coca-Cola, Procter & Gamble, and Johnson & Johnson).

The iShares Barclays TIPS Bond Fund (NYSEMKT: TIP) declined by a staggering 7.6%. The perceived risk of owning a bond is driven by the Federal Reserve. Investors cannot ignore the Federal Reserve because it is the most powerful leading indicator that is available.

<img alt="" height="365" src="http://g.fool.com/editorial/images/55091/7-2-13-gld-pic-3_large.jpg" width="725" />

Source: CNBC

Bonds are generally perceived as safe but were sold off in the market the past month. This was driven by the fact that the Federal Reserve is finally committed to ending its long-term monetary easing practices. There’s potential tapering of bond and mortgage-backed security purchases towards the end of 2013. However, this is only if the economy meets the targeted real GDP growth rate of 2.3 to 2.6% and the targeted inflation rate of 2%.

I believe that the economy will reach the Federal Reserve’s targets, and because of this, it will only be a matter of time before bond outflows become even more severe.

That being the case, gold hasn’t been shown to be a better hedge against risk. So it would be practical to avoid the SPDR Gold Shares Trust (NYSEMKT: GLD). The central argument to owning gold was the argument of hyper-inflation. But with that perceived risk more or less dead in the water. Our investment portfolio would perform better by looking for alternative trading opportunities.

Short the gold miners

Yes, you heard me say it. Short the gold miners. I believe that the value of gold will fall even lower. I think two stocks may, in fact, underperform the market the most. Gold Fields Limited (NYSE: GFI), and AngloGold Ashanti (NYSE: AU). Both companies have rising liabilities and falling short-term cash and cash equivalents. Because of this, the companies may be in the very early stages of insolvency.

The total cost of mining an ounce of gold has increased from $280 in 2005 to $775 according to BMO. The price of gold is currently $1,256 per ounce, so that given enough time profit margins may shrink even further. The hit to profit margins will reduce the amount of cash flow. Falling cash flow with high levels of debt is always a bad thing.

<img alt="" height="415" src="http://g.fool.com/editorial/images/55091/7-2-13-gld-pic-4_large.png" width="736" />

Source: Ycharts

A consensus of analysts anticipate AngloGold Ashanti to report a 39.4% decline in earnings for the current fiscal year. If earnings continu to decline, then investors will continue to sell the stock.

The perceived risk of owning a gold miner has gone up. So each bit of positive news won’t have as much of a positive effect on the stock. Likewise, each bit of negative news will have more of a negative impact on the price of the stock. The stock trades at a 19.2 earnings multiple, making it heavily overvalued relative to its projected decline in earnings.

Gold Fields is projected to do even worse in the current fiscal year. Analysts on a consensus basis anticipate the company to report a 44.3% decline in earnings for the current fiscal year. The stock is trading at a 13.6 earnings multiple. The stock is heavily overvalued because of the negative earnings growth that is projected.

Gold Fields has more in liabilities than AngloGold Ashanti, and it also depleted the amount of cash and cash equivalents on its balance sheet quicker. It can be assumed that Gold Fields is closer to insolvency than AngloGold Ashanti.

Conclusion

Be a seller of gold and bonds. The perception of both gold and bonds will worsen in the future. Instead, investors should consider owning cash and a diversified holding of stocks through the ownership of the SPDR S&P 500.

Those who are looking to generate higher investment yields should consider a short on AngloGold Ashanti, and Gold Field.


Alexander Cho has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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