If you thought the financial crisis was a wild ride for investors, then the coronavirus disease 2019 (COVID-19) pandemic has completely raised the bar. In just a few short months, equities have packed in about a decade's worth of volatility. We've witnessed the fastest and steepest correction in history, followed by one of the strongest quarterly performance in history (Q2), as well as a brief period of negative oil prices.
For many investors, it's been a challenging year. That is, unless you were holding precious metals like gold.
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Few investments are looking as lustrous at the moment as physical gold. Over the past six months (through Monday, July 27), gold is up $363 an ounce, which is good enough for a 23% increase. The precious metal has now bounced almost $900 off of its decade-low of $1,050.60 an ounce, set back in 2015.
The question is, with gold notching a new all-time high on Monday, should you be buying gold stocks, or taking this as your cue to avoid the industry?
Let me not beat around the bush. Yes, you should be buying gold stocks right now.
Three reasons physical gold is nowhere near a peak
To be perfectly clear, no one can predict the very short-term movements in any asset, including physical gold. Having gained over $100 an ounce in just the past week, it's not out of the question that the lustrous yellow metal could have a few bad days here and there. Remember, no asset goes up in a straight line. But there are three key reasons physical gold is primed to outperform, and perhaps even approach $3,000 an ounce in the coming years.
First of all, global bond yields have been plunging for a while, leaving income seekers with few avenues to make a buck. Even if bondholders are generating a positive nominal return, they're likely to lose real money to inflation over a longer period of time. These persistently low yields make gold, an asset that doesn't offer a yield, all the more attractive as a store of value or as an investment.
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Secondly, central banks around the world (and especially in the U.S.) have rolled out the red carpet for physical gold to thrive. In the U.S., unlimited quantitative easing will mean a huge jump in the money supply, which is almost always bad news for the U.S. dollar. Since the dollar and gold move opposite of one another, central banks throwing money at their respective ailing economies is a big-time boost for the yellow metal.
Third, keep in mind that gold investing cycles tend to last for long periods of time. Though we've recently hit a new all-time high for gold, you should realize that it's been rallying for more than four years. The last bull market in gold went on for more than a decade. Historically speaking, the tail-end of a recession through the first 18 months of an economic recovery is when gold shines brightest.
Here's why you should consider buying gold stocks and not physical gold
However, owning physical gold isn't the best way to play this ongoing rally. Instead, you're going to want to consider buying gold stocks or an exchange-traded fund that owns gold stocks.
Why mining stocks and not physical gold? First, the leverage is considerably greater with gold stocks. If gold rises another $100 an ounce, you'd make a little over 5% on your investment in the physical metal. But if a gold mining stock sees an extra $100 in average selling price, its cash operating margin per ounce will probably rise by a double-digit percentage.
Additionally, gold mining companies have the ability to proactively and reactively respond to market conditions. New mines can be brought online or costs can be reined in, depending on existing market conditions. That's not something that's a consideration with owning physical gold.
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To build on this point, management teams and boards also have the power to reward shareholders through capital return programs. This may involve a dividend or share repurchase program. By comparison, physical gold offers no perks of ownership.
Finally, it's a lot easier to peruse an income statement or balance sheet for a publicly traded company than it is to navigate macroeconomic data on physical gold.
In other words, it's a no-brainer to buy gold stocks if you believe physical gold is in a long-term bull market.
These gold stocks should have plenty of upside
Since I've established that buying gold stocks right now is a smart move, how about a quick look at some of the most attractive names in the industry.
First up is Kirkland Lake Gold (KL), which has the most pristine balance sheet of any gold stock. Kirkland Lake ended March with $530.9 million in cash and no debt despite having recently completed the acquisition of Detour Gold. Even with this buyout temporarily increasing the company's all-in sustaining costs (AISC) to $776 per gold equivalent ounce (GEO), it's generating close to a $1,200 cash operating margin per GEO at the moment.
It's also worth mentioning that Kirkland Lake doubled its dividend and repurchased $330 million worth of its stock just in the first quarter. Every move being made is designed to make shareholders money.
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Another gold stock with plenty of upside is Yamana Gold (AUY). Yamana got itself into a bit to trouble back in 2014 when it and Agnico Eagle Mines acquired Osisko Mining. This deal and some early decade expansion weighed Yamana down with quite a bit of debt. But as of the end of its most recent quarter, Yamana has slashed its net debt to $768 million. All the while, new assets have come online (Cerro Moro), operational efficiency is improving, and AISC should continue to decline. Yamana is likely to see 1 million GEO produced in 2021 and 2022, up by a low double-digit percentage from what it'll produce this year.
Similar to Kirkland Lake Gold, Yamana Gold has been putting its operating cash flow to work to improve shareholder value. The company has increased its dividend four times over the past year, and it anticipates paying off its $100 million revolving credit line with its extra cash flow before the end of the year. Just keep in mind that for every $100/oz. gain in gold above $1,750/oz., it'll net an extra $70 million in net free cash flow.
