QE3: Many Ways for Gold Bugs to Play

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

Recently Federal Reserve Chairman Ben Bernanke introduced a new round of quantitative easing (QE3) in which the Fed will purchase $40 billion a month of mortgage backed securities. This is seen as an especially bold and controversial, move by the Fed, as opposed to other rounds of easing, because unlike past rounds the Fed did not put a cap on the amount it would purchase. Rather Bernanke pledged to purchase the securities each month until employment "improved substantially". This is seen as a shift from previous policy because the Fed is placing an emphasis on economic growth rather than price or market stability, a move in which critics claim will lead to rampant inflation.

*source: Reuters

Regardless of whether or not you approve of "QE infinity" investors can expect the following trends to continue:

  • interest rates will remain at historic lows through at least 2015 as opposed to the previous goal of 2014
  • the stock market (because bond rates will be so low) should remain in bull mode
  • the price of gold will rally much higher


All That Glitters:

Recently the idea that the bull market in gold would continue might be the one opinion that the market had been the least sure of. In fact the price of gold, which had done nothing but gain ground in recent years, had actually faltered recently as positive economic data surfaced the past few months. Investors became less sure that there would be another round of quantitative easing (which only underscores the impact easing has on gold) which caused the metal to come down in price. Now that the easing has no end in sight prices will go much higher; in fact they jumped over 2% on the first trading day of the news hitting highs of $1,772 an ounce just a smidge, away from the yearly high of$1,790. With QE3 not only will the dollar be devalued (sending investors flocking to gold) but if you do believe as I do that it will cause inflation, gold will rally as the ultimate hedge. So the real question now is, how do investors profit from the precious metal?

Heavy Metal, Well Not Exactly:

If you're like most investors (present company included) you can't very well purchase a gold bullion and that's nothing to be ashamed of. The next most direct way to purchase the metal is to purchase shares in the ETF SPRD Gold Shares (NYSEMKT: GLD), these shares trade like a stock with the stated mission  "to replicate the performance, net of expenses, of the price of gold bullion." The trust actually holds gold bullion, so when you purchase a share you are performing the closest action to purchasing bullion, only at a price you can afford. The shares of GLD have varied from $148.27-$176.86 this year, a nearly 20% variance, and they currently trade at about $172. If you choose to go this route, it is this humble observers opinion that you do not wait for a pull back, with QE3 we are likely to be in full gold bull mode for some time. With that being said, since the ETF provides liquidity that purchasing bullion doesn't, you can build your position in small increments over time.

Drill Baby, Drill:

QE3 doesn't only mean that gold will continue to rise, it's also bullish for the stock market. Think of investing like shopping at the supermarket, investors have to choose what to buy and what the best value, stocks or bonds is. With the Fed vowing to keep interest rates low the returns on bonds will continue to be meager. Therefore the only reasonable alternative for investors is stocks and they should continue to rally in spite of the economy (especially dividend payers) as investors have nowhere else to earn a decent return. As much as gold has wavered this year it's nothing in comparison to what the stocks of companies that mine for gold have faced, many are just now coming off yearly lows and trade at very low multiples. If you'd like to be in gold but also want the potential upside stocks offer, you may want to take a look at these two beaten down, large cap value plays.

<table> <tbody> <tr> <td>Company:</td> <td>P/E(TTM)</td> <td>Forward P/E (1yr)</td> <td>52 week low/high</td> <td>Variance between low/high</td> <td>dividend yield%</td> <td>market cap</td> </tr> <tr> <td>Barrick Gold Company <span class="ticker" data-id="206868">(NYSE: <a href="http://caps.fool.com/Ticker/ABX.aspx">ABX</a>)</span></td> <td>10.34</td> <td>8.65</td> <td>$31.00-$55.20</td> <td>nearly 80%</td> <td>1.89%</td> <td>$42.4B</td> </tr> <tr> <td>Freeport-McMoran Copper & Gold <span class="ticker" data-id="203558">(NYSE: <a href="http://caps.fool.com/Ticker/FCX.aspx">FCX</a>)</span></td> <td>12.85</td> <td>8.15</td> <td>$28.85-$48.96</td> <td>nearly 65%</td> <td>2.93%</td> <td>$40.5B</td> </tr> </tbody> </table>

Barrick is the world's largest gold company in terms of both production and reserves. This company does nothing but mine for gold yet its stock price has remained suppressed for some time. It is worth pointing out, that the company missed its most recent quarterly earnings by 20%, but it has been a consistent performer for years. Barrick's earnings grew nearly 40% from 2010 to 2011 and analysts expect them to grow 20% in the next year; keep in mind this year’s earnings estimates were made before the QE3 announcement. Barrick's amazing growth from 2010 to 2011 of 40% was based chiefly on rising gold prices; this company is only involved in gold so when the prices rise, the stock should follow. Although the shares did rise nearly 2% on Bernanke’s announcement you can still get shares at only $42.38, far off their 52 week high.

For those looking for a good opportunity in gold but some diversity as well, Freeport-McMoRan should be an excellent choice. Freeport is one of the world’s largest producers of copper but also is a large producer of gold. While gold only accounted for 12% of its revenues in FY2011, to put it in context that was nearly 1.4 million ounces. Investors should only invest in Freeport however if they believe that the stock market and world economies will rally going forward, as the company is heavily invested in copper which suffers wild price swings on bad economic news. That being said analysts expect earnings to rise by nearly 40% next year, and again, these estimates were pre-QE3 announcement (the stock rallied 2.03% on the news). Freeport currently trades at just under $42.64/share.

One note on these two opportunities, while I expect both companies to do well, it is worth mentioning that as noted in the tables above both companies have a large market cap. Companies of this size have already (despite what analysts’ project) captured large amounts of their addressable market and it would be irresponsible for me to predict either to be a multi-bagger. These are two unloved value plays, that should rise to full value (above their 52 week highs) as gold prices rise, all while paying a healthy dividend. They are safer stock investments and both are large enough that it's unlikely you'll lose your entire investment.

Multi-bagger or Bust:

For those who want to profit from the rise in gold and are willing to take on a little more risk for a greater potential reward, they may want to look at the little known small cap EZCORP, Inc. (NASDAQ: EZPW). The company owns and operates pawn stores in the U.S. and Mexico as well as short term consumer loan stores.

<table> <tbody> <tr> <td>Company Name</td> <td>P/E Ratio (ttm)</td> <td>Forward P/E (1yr)</td> <td>52 week low/high</td> <td>Variance between low/high</td> <td>market cap</td> </tr> <tr> <td>EZCORP, Inc.</td> <td>8.94%</td> <td>7.73</td> <td>$21.93-$33.93</td> <td>nearly 55%</td> <td>$1.26B</td> </tr> </tbody> </table>

 

This company is a particularly interesting one, until recently it had been on an absolute tear rising from $11.88 in 2008 to a high of $37.62 in July of 2011. What makes it so interesting is the stock didn't face the typical drop that others did during the "Great Recession" because it is a company that profits from pain. When banks won't lend, pawning (the oldest form of lending) and pay day loans become the best source of credit. 

Investors are almost always best suited when their stocks are on the right side of a long term bullish theme. I believe EZCORP delivers two, the pawn business in incredibly reliant on gold so the rising price of gold could carry the stock and it's pawn and loan business is benefiting from the decrease in standard bank lending.

The stock has pulled back recently to where it currently trades at $24.90 (it also rose 2% on the news) due to a recent quarterly miss of 11%. The prime culprit for the earnings miss? You guessed it, moderating gold prices which resulted in a 26% same store decrease in jewelry scrapping sales and a 19% same-store decrease in jewelry merchandise sales. Even so, the company still saw a net income growth of 8% and revenue growth of 13%; analysts expect earnings to grow 15% this year. The company remains in super growth mode, opening 139 new stores last year, now imagine what the earnings in those stores will look like if gold continues to rise and that decline in jewelry scrapping and sales reverses! Considering the company did pretty well with a 26% decline in this segment, I like their chances! Finally, with a market cap of just $1.26B this is (in my opinion) the play on gold with a real chance to be a multi-bagger because it has the most room to grow. It is worth mentioning that this is a small company that has been pretty volatile and while I'm bullish on the stock, you'll want to do plenty of your own homework before buying.

Summary:

With the decision by Fed Chairman Ben Bernanke to begin QE3 (oh, let's just call it QE infinity) the price of gold is almost certain to stay near or break record highs. I strongly believe, with the Feds commitment to low interest rates that the stock market will continue to rise as well. With these developments you should be in gold of some form. If you prefer to avoid the ups and downs of the stock market, GLD is your safest bet. For those investors who want to be in stocks and gold but favor a little stability; I believe you can't go wrong with the upside (or dividends) of FCX and ABX. Finally, for you thrill seeker gold bugs out there who want the chance at a multi bagger and can handle the risk, EZPW is certainly worth looking into. The market offers enough opportunities to be in the precious metal to satisfy all risk tolerances; pick yours an buy one, sooner rather than later.

 


Adem Tahiri has no positions in the stocks mentioned above. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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