A golden opportunity

Standard & Poor’s Equity Research remains positive on the outlook for gold and gold stocks for 2010. While the price of gold has been rising steadily since 2001 and reached its highest average level ever in 2009, S&P’s Metals & Mining equity analyst, Leo Larkin, believes that the price will rise again in 2010, for several reasons.

First, Larkin believes short-term interest rates will remain at low levels. Notwithstanding an anticipated economic recovery and a forecasted rise in the Consumer Price Index in 2010, he believes it is unlikely that the Federal Reserve will raise short-term interest rates significantly given the S&P forecast for an increase in the average unemployment rate to 9.8% in 2010 from 9.3% in 2009. Low short-term interest rates reduce the opportunity cost of holding gold as an investment.

Second, despite the higher gold price, global mine production has been declining for the past 10 years. The low level of gold prices in the late 1990s led to a drop in exploration and large new discoveries. According to data compiled by Gold Fields Minerals Service, a U.K.-based metals consulting firm and publisher, global mine output decreased from 1999 through 2008. Larkin believes that production will remain stagnant for the next several years, as old mines are becoming depleted and are not being replaced to the extent needed to lift output. This, combined with rising investment demand, should help boost the gold price.

Third, Larkin expects that greater volatility of the major world currencies will increase demand for gold as a monetary reserve asset. He also believes that China and other countries that hold a large portion of their foreign exchange reserves in U.S. dollars will ultimately diversify out of the dollar and into other currencies and gold. Finally, Larkin thinks that gold will rise in all currencies due to the implementation of quantitative easing by governments throughout the world.

After lagging the gold price and the S&P 500 in 2009, the S&P Gold index was up 7.7% through March 31, 2010, versus a 4.9% increase in the S&P 500 and a 1.5% rise in spot gold.

Based on his expectation for a further rise in the gold price in 2010 and increased production volumes, Larkin looks for a sizable gain in sales and earnings for this group from 2009’s levels. For the group in aggregate, Larkin projects EPS growth of almost 56% in 2010 over 2009, with the bulk of the projected gain being accounted for by Lihir Gold and Randgold Resources.

Larkin believes that the forecasted gain in earnings will result in increased free cash flow, which, in turn, should enable companies to fund expansions at existing mines with less resort to dilutive financing. Additionally, he expects merger activity to pick-up as companies look to increase production and reserves via acquisitions, which should increase the investment appeal of this group.

Larkin expects the spot gold price to end 2010 at about $1,300 per ounce, versus 2009’s year-end price of $1,097 per ounce. On this projection, gold has upside of nearly 17% from the price of $1,115 per ounce as of the end of March. Near-term, S&P thinks the gold price will drift sideways but should end 2010 with a strong rally as increased world economic growth lifts commodity prices.
For investors who like the gold thesis, the next question becomes how one goes about putting it into action in one’s portfolio. Answering that question depends in part on gauging an investor’s investment objectives and risk tolerance. For individual gold stocks, S&P Equity Research has buy (4-STARS) recommendations, as of March 31, 2010, on Barrick Gold (ABX), Newmont Mining (NEM), and Randgold Resources (GOLD); S&P also has a hold opinion on Lihir Gold (LIHR). S&P’s STARS recommendations are subject to change at any time, as are its ETF and mutual fund recommendations.

In contrast, investors looking for exposure to gold, but who also want to benefit from holding a diversified security (which may also include exposure to non-gold stocks), may consider exchange-traded funds or mutual funds. S&P rankings on ETFs and mutual funds incorporate a rigorous analysis of each portfolio’s underlying holdings to assess valuation and risk, and are not based simply on past performance.
On the ETF front, there is a distinction to be made between ETFs that invest in gold stocks and ETFs that take possession of the physical commodity itself. For those that invest in gold stocks, as of March 31, 2010, S&P has marketweight ranking on Market Vectors Gold Miners ETF (GDX), iShares S&P North American Natural Resources Sector Index Fund (IGE), iShares Dow Jones US Basic Materials Sector Index Fund (IYM), iShares MSCI Canada Index Fund (EWC), Claymore/BNY Mellon EW Euro-Pacific LDRs ETF (EEN), Materials Select Sector SPDR Fund (XLB), and Vanguard Materials Index Fund ETF Shares (VAW). Amongst this list of ETFs, GDX would appear to offer the strongest exposure to the gold play, with S&P-recommended gold stocks occupying, as of March 31, 2010, the #1, #3, and #10 positions within its top-ten holdings. All of the other listed ETFs have at least one of the S&P-recommended gold stocks within their respective top-ten holdings, but also include significant exposure to other materials stocks or even issues from other sectors.
In the case of ETFs taking physical possession of gold, there are several well-known ETFs, including SPDR Gold Shares (GLD) and iShares Comex Gold Trust (IAU); S&P offers current details on these ETFs but does not offer rankings on them at this time.

As for mutual funds, S&P has a top five-star ranking on these equity funds, all of which have a top-ten holding in at least one of the above recommended gold stocks: Franklin Gold & Precious Metals Fund (FKRCX), American Funds New Perspective Fund (ANWPX), Nuveen Tradewinds Global All-Cap Fund (NWGAX), USAA Precious Metals & Minerals Fund (USAGX), Tocqueville Fund (TOCQX), and Tocqueville Gold Fund (TGLDX). All six funds are also open to new investors.

Note: The fund rankings in this article — from five star (best) to one star (worst) — are quantitatively derived from performance, holdings, risk, and expense analysis. The stock rankings, or STARS — using a scale of 5-STARS (strong buy) to 1-STARS (strong sell) — are based on S&P equity analysts’ qualitative and fundamentally-driven outlook for the stock over the next 12 months; NR stands for not ranked.
To get access to Standard & Poor’s Equity Research go to www.getmarketscope.com, or call 1-877-219-1247, or send an email to [email protected].

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