After QE3 Announcement, Buy These 2 Gold Stocks
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After the Fed announced another round of stimulus through QE3, gold stocks continued on a nice surge. Eldorado Gold (NYSE: EGO), New Gold (NYSEMKT: NGD), and Yamana Gold (NYSE: AUY) have gone up 6.9%, 9.5%, and 10.6%, respectively, over just the last 5 trading days alone. On one side, you have the bulls. This side argues that endless government spending will drive concerns over inflation and send investors over to safe basic materials. Then, on other side, you have the bears. They argue that inflation is a non-issue under today's monetary intervention. For evidence that gold is overvalued, they point to Warren Buffett who has expressed how all the gold in the world should not be worth 16 ExxonMobils. Both sides have valid points, but which one will point investors to larger returns in the near term? In my view, it's a case by case decision.
New Gold - Don't Buy
The reason why I recommend not aggressively buying is because if you look at New Gold, for example, you will see that much of the value is locked up in an uncontrollable precious metal. Fundamentals depend on something more controllable, like volumes. In this regard, New Gold has not done fantastic. The El Morro mining interest in Chile is facing federal pressure over environmental issues. At the same time, the firm is looking to payout a dividend from the debt that it recently raised. It's unclear how big of a catalyst this will be for shareholders, since larger gold producers, like Barrick, already offer shareholder-friendly capital allocation policies. This means smaller, less secure firms are unlikely to gain interest from some of the risk-averse shareholders regardless of whether or not they begin to offer distributions. Although New Gold is able to be valued at 2.5x book value due to high annual double-digit EPS growth over the past 5 years, like many miners, it still spends more than half of its revenue on capital expenditures. Accordingly, ROA, ROE, and ROI are all in the low single-digits.
Yamana, Eldorado - Both Safer Bets...
While I am more bullish on Eldorado and Yamana, both have admittedly shown their own operational shortcomings. The last three quarters for the former have been terrible with a string of misses over the last three quarters. 1Q12 and 2Q12 results were also weak at Yamana, but the firm managed to beat expectations by 1 cent at EPS of $0.25 in 4Q12, which is meaningful given how the industry has been more challenging than originally anticipated.
On April 13, BMO Capital Markets released an outperform rating for Eldorado and bumped their price target from $18.50 up to $20. The stock currently trades at $15.13, so there is a good amount of upside against expectations. With transformative EPS growth in recent years, there is more reasons to be optimistic about Eldorado than pessimistic.
Due to the rise in competition and increased political uncertainty, multiples have plummeted. The firm trades at a price-to-book multiple that is less than half of the historical 5-year average; ditto for price-to-earnings and price-to-sales. With the economy still uncertain, these overly multiples provide a strong reason to buy shares sooner rather than later. I believe investors will look beyond the competitive pressures and buy if they become more weary about the wider economy.
But Yamana is Even More Attractive
Yamana looks even better, in my view, with the company getting aggressive in takeover activity. It recently purchased Extorre - a $414 million transaction that the market has reacted favorably to thus far. From the Cerro Moro project to reserves located closer to domestic shores, the company is well diversified in junior operations that promise strong upside. The takeover of Extorre will produce $325 million in operating cash flow each year against a $110 million capital expenditure cost. In the long-term, this site may deliver as much as a tenth of Yamana's production. Extorre was backed into making the deal at such a low price due to an inability to pay for the budget by itself. In this way, Yamana can leverage its strong balance sheet to further gain scale and become the coveted gold stock. For this reason, I recommend preferentially buying shares in gold.
Historically, gold has been a way to hedge against macro "tail risks" - unlikely, but plausible, devastating turns in the economy. While I wouldn't recommend getting too heavy in any of these stocks, some diversification is recommended. Eldorado and Yamana both look like fundamentally solid stocks to back in the short-term with little visibility on the economy. While they are not my favorite basic materials stocks, they have compelling growth stories with minimal downside. In later articles, I will point to producers in the field that I believe have even greater upside.
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