By: Austin Hatley of Street Authority
After steadily returning an average of 18% a year for the past decade, gold is headed for its first annual loss since 2000. All told, gold prices have fallen over $450 an ounce since January -- a 27% decline in just under 12 months.
In part, the gold market is suffering thanks to the economic recovery. Since gold is usually seen as a "safe haven" investment, an improving economy puts downward pressure on gold prices. Other headwinds include low inflation rates... surging equity values... and an overwhelmingly bearish sentiment facing commodities altogether.
Before I go any further though, I want to note that it's never a bad idea to devote at least a small portion of your portfolio to precious metals. Since these assets are generally insulated from rising price levels, metals like gold are a good way to hedge against inflation risk.
But gold bullion is not the subject of today's essay. Instead of touting the monetary benefits of the world's oldest currency, I want to tell you about one of the most overlooked (and misunderstood) areas of the gold market...
I'm talking about gold stocks.
"Gold stocks" is a financial synonym for gold mining companies -- the guys who get paid to physically pull the yellow metal out of the ground. Since miners earn their paychecks by selling the gold they produce, gold stocks have historically moved in tandem with gold prices.
But that hasn't been the case lately. For the past few years, investors have been unusually harsh on gold miners.
As you can see from the chart, in the last 12 months gold stocks have fallen 55% -- nearly 30 percentage points more than bullion during that same time period.
Other than low prices, gold miners are also being punished due to investor fears that rising production costs are eroding profitability.
According to precious metals giant Royal Gold (Nasdaq: RGLD), the average cost to recover an ounce of gold was $662 in 2011. By 2012 that number had risen to $1,000. Today it's estimated to cost at least $1,200 for the average gold miner to pull a single ounce of gold from the earth.
With the price of gold trading at $1,250 an ounce, it doesn't take a Ph.D. to understand why gold miners are trading at fire-sale prices. Of the 31 companies held in the Market Vectors Gold Miners Fund (NYSE: GDX), the average price-to-book ratio has fallen to a 15-year low.
A 'Once In A Lifetime' Opportunity In Gold
Those depressed valuations have piqued the interests of Dave Forest -- StreetAuthority's resident commodities expert.
As a trained geologist with over 10 years of experience, Dave has seen his share of ups and downs in the commodities markets. But even after spending over a decade in the industry, never has he seen a phenomenon of this magnitude.
In fact, Dave recently told subscribers to his premium newsletter -- Junior Resource Advisor -- that gold stocks are presenting a "once in a lifetime" opportunity... citing that right now investors have the "chance to buy the right companies at unimaginably low" prices.
Specifically, he was talking about stocks like Alacer Gold (OTC: ALIAF) -- a junior mining company that's fallen over 33% in the past two months.
After the pullback, Dave thinks Alacer looks like a "no-brainer" investment. As he recently told his Junior Resource Advisor subscribers:
It's times like these I remind my fretting nerves, "This is what money-making opportunities look like!" They look like Alacer Gold (OTC: ALIAF), which has fallen 33% since I recommended it less than a month ago.
The fundamentals help to soothe the caveman in me who wants to run screaming from a crumble like this. I remind myself that this is a company that's going to make upwards of $200 million next year, after-tax. That's not dependent on gold prices going up -- current prices of $1,240 per ounce will be just fine. Alacer's current all-in production costs are only $700 per ounce.
That figure jolts my panicked mind back to reality. It's not often I can find a company that makes $200 million a year trading at just a $370 million valuation. And at less than 2x after-tax income.
Put those numbers together and you start to get tantalizingly close to a 1x multiple to after-tax income at the current $2.02 share price. Buying a business that will pay me back in 12 months is a proposition that doesn't come around very often, certainly not when times are good and investors are happily slinging cash about.
In other words, unlike most mining companies, Alacer can still earn a profit when gold is trading at $1,200 an ounce. With all-in costs of $700, gold prices could fall another 42% before the company would post a loss.
What's more, one of the best parts about this company is that its top producing mine -- the Copler mine of Eastern Turkey -- is still brand new. Since it was just commissioned in 2011, there is still plenty of high-quality ore that's yet to be recovered from the company's principal lease holding. Those positive growth factors recently prompted management to increase its 2013 production forecast by 20,000 ounces.
If you are thinking about investing here though, it's important to tread carefully. As we showed you earlier, gold stocks can be a volatile proposition. If the sell-off in gold continues, miners could continue to suffer in the short term.
But in the long run, Dave doesn't think that will be a problem for Alacer. With one of the lowest-cost mines in the business and a management team that has a history of finding and extracting some of the most profitable gold reserves on Earth, this company is likely to be a winner if (and when) gold stocks come back in favor.
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