In the face of historic monetary stimulus from nearly every major central bank in the world over the past few years, an investment in gold would have seemed to be a "no-brainer." Yet the precious metal's price, around $1,178 per ounce, has barely budged.
Now may be the time to give gold a fresh look. Fundamental drivers appear in place for long-term upside, and technical support could provide a near-term catalyst.
Moreover, shares of gold mining companies are selling at steep discounts to historical multiples and the slightest hint of stabilization could bring investors back in a big way. A confirmation of fundamentals for gold prices would send gold mining shares soaring.
Fundamentals May Finally Be Turning Higher For Gold
Gold's recent subdued performance can be attributed to tepid global growth that has kept inflation at bay. Yet there are signs that both are on the way up.
The World Bank estimates global growth of 2.8% this year and 3.3% in 2016. Economic growth in the stagnant eurozone is expected to jump 1.5%, the fastest pace since 2010. Prices in the eurozone rose a stronger-than-expected 0.9% in June (year-over-year), the fastest pace in nine months.
While the Federal Reserve has come off its historic monetary easing programs, the Bank of Japan and the European Central Bank are still pursuing them: the Bank of Japan is injecting 80 trillion yen per year into its financial system and the ECB will have pumped more than $1 trillion into its financial system by September 2016.
Those actions should help underpin economic growth. And higher inflationary expectations may not be too far off. The International Monetary Fund estimates that nearly every developed economy is on the verge of accelerating inflation.
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Beyond the economic impetus for gold prices, falling capital expenditures by the largest gold miners could limit supply growth over the next several years. The average capital investment last year by the five largest miners was less than half of that spent in 2012. The World Gold Council reported that global gold supply dropped 4% sequentially in the first quarter of 2015.
Meanwhile, the current Greek crisis may lead to a win-win situation for gold investors. Volatility has jumped with the possibility of a Greek default and gold prices have held up as invests rush back to the safety of the yellow metal.
If a deal is eventually reached to avoid a Grexit, then the U.S. dollar would likely fall as investors look for higher-yielding opportunities internationally. This should send gold prices soaring since the metal is priced in dollars.
Technicals Point To Near-Term Support For Gold Prices
Beyond the underlying support from fundamentals, gold prices may see technical support as well. StreetAuthority colleague John Kosar recently cited hedging data from the Commodity Futures Trading Commission that indicates "smart money is making an aggressive bet that gold is undervalued at near $1,200 per ounce."
John suggested that gold prices will support the SPDR Gold Trust (NYSE: GLD) above its 200-day moving average at $115.97 per share and provide a buy signal to traders going forward.
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Investor sentiment might already be returning to gold: Q1 2015 saw the first net purchase in gold exchange-traded funds since Q4 2012. The World Gold Council reports that ETFs added 26 tons of gold to storage after eight consecutive quarters of decline.
Two Low-Cost Producers With Big Upside
Beaten-down mining stocks could surge if gold prices head higher, but the risk for another few months of stagnation is still a possibility. Investing in low-cost producers gives investors the opportunity to take a position without having to worry about how quickly a rebound materializes. Two such companies instantly stand out.
Eldorado Gold Corp. (NYSE: EGO) is the largest foreign gold miner operating in China, the world's largest gold-producing country. The company benefits as one of the lowest-cost producers in the industry, with all-in sustaining costs of $780 per ounce in 2014, versus an industry average of around $956 per ounce. The company is able to produce at a lower cost because of its focus on less-developed regions in Turkey, China, Greece and Brazil.
Eldorado carries increased geopolitical risks, but liquidity of $875 million -- including $500 million in cash, cash equivalents and term deposits and $375 million in available credit -- will help it weather any prolonged sector weakness. Operating assets have a reserve life of 21.7 years, meaning the company should be able to keep production going even on low capital spending.
Its shares trade for just 2.9 times the trailing sales compared to an average multiple of 8.3 times over the last five years. My target of $5.45 per share is based on a multiple of 4.4 times expected 2015 sales of $871 million. That represents a 35% upside.
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Yamana Gold, Inc. (NYSE: AUY) may be a slightly safer play in terms of geopolitical risks with its production focused in Canada and South America. The company's all-in sustaining cost is higher at $896 per ounce, but still lower than the industry average and 13% lower from a year ago. Yamana holds 20 years' worth of proven and probable reserves and books a quarter of sales from silver and copper mining as well, providing some diversification from gold prices.
Yamana recently announced construction at its low-cost Cerro Moro project in Argentina that is expected to produce at an all-in sustaining cost of around $557 per ounce. Average annual production, in the first three years, of 135,000 ounces of gold will make Cerro Moro one of the company's largest projects and will significantly bring down the total all-in sustaining cost. Shares trade for just 1.4 times trailing sales compared to an average multiple of 4.7 times over the last five years. My target of $3.98 per share is based on a multiple of 1.8 times expected sales of $2.02 billion this year. That represents more than 30% upside.
Risks To Consider: Weak global growth and inflation could still limit gold prices this year and investors may need to wait the trade out for a year or more. Lower-cost producers offer safety until gold prices pick up, and they offer strong upside on valuation.
Action To Take --> Look for technical and fundamental forces to push gold higher through the year and take advantage of low valuations on gold miners.
Editor's Note: If you want the latest news on gold's rebound -- or oil and other natural resources for that matter -- then look no further than StreetAuthority's Scarcity & Real Wealth. Our resident natural resources expert Dave Forest has more than a decade's experience as a trained geologist and analyst. His industry insight allows him to read the markets and provide the most timely, potentially lucrative advice for everything from oil and gold to molybdenum. To gain access to Dave's latest research, click here.