Many investors in gold bullion have become increasingly worried due to the lack of price appreciation lately. Even though there has been an aggressive monetary policy initiative by the Federal Reserve, gold bullion and mining stocks in the sector have declined.
Obviously, no one can predict the future; it’s impossible to know for sure where gold bullion, or mining stocks in general, will be in the future.
However, there are several things that individual investors can do to enhance their probability of success when it comes to investing in gold bullion mining stocks.
One metric that I watch is the debt level of a company. This doesn’t mean to avoid all mining stocks with high levels of debt; rather, one should only buy these companies at a discount, unless they are growing rapidly. Gold bullion mining stocks with high levels of debt are far more likely to be susceptible to negative shocks.
Because interest rates have been low for some time, gold bullion mining stocks with high debt have been able to get away with relatively low rates of financing. But over the next five years, we are certainly looking at a higher interest rate environment; this is one area of caution for investors.
One way to look at gold bullion mining stocks is in two general categories: low- or no-debt mining stocks and high-debt mining stocks. The companies with a high debt level should not trade at a premium when compared to gold bullion mining stocks with low levels of debt, unless their growth rate is above average.
Here are three stocks that are great examples.
One of the largest gold bullion mining stocks is Newmont Mining Corporation (NYSE/NEM). This is a company with over $6.0 billion in debt, which is a debt/equity ratio of 37.1 and trades at a premium with a price-to-book ratio of 1.7, even though revenues and earnings are declining. (Source: Yahoo! Finance, last accessed January 24, 2013.)
One of the smaller gold bullion mining stocks is Brigus Gold Corp. (NYSE/BRD). This company also trades with a relatively high debt level, with its debt/equity ratio at 31.8, but it trades at a slight discount to price/book value just below one and has a revenue growth rate over 50%.
Then we go to Nevsun Resources Ltd. (NYSE/NSU). This is one of the gold bullion mining stocks that have no debt. With over 40% of the share price in cash, it trades at a premium of its price-to-book ratio of 1.5. While revenue was slightly down, a massive cash position and no-debt level are strong supports for shareholders.
What these three stocks show is that it’s okay to invest in a company with a high debt load, as long as you’re not paying a premium. The reason is that the less debt a company has, the greater flexibility there is for the firm. Once debt becomes exceedingly high, an increasingly large amount of cash needs to be spent paying off its financing.
With gold bullion remaining flat, shareholders in mining stocks cannot automatically assume that the commodity will rise substantially. If gold bullion remains flat or even declines further and we see higher interest rates, this will put a massive squeeze and a negative impact on earnings for mining stocks with high debt levels.
Unless the gold bullion mining stocks are smaller companies involved in exploration and able to find and grow their reserves, larger mining stocks could have a significant negative impact over the next five years. This is because larger gold bullion mining stocks tend to be steady producers of gold bullion. They make the spread—the difference between what their cash cost is to extract gold bullion and the market price.
If gold bullion mining stocks have high levels of debt and the cost to carry this load increases, then their earnings will be directly hit. Plus, most senior gold bullion mining stocks are not substantially growing reserves.
As with any sector, not all mining stocks are the same. This is a brief overview of one metric that an investor needs to be aware of when considering gold bullion mining stocks. One fundamental metric is not enough to make an investing decision, but debt load is something worth considering, and it should be part of one’s comprehensive due diligence.
By: Sasha Cekerevac
Posted: January 28, 2013, 7:43 am
We believe the stock market and the economy have been propped up since 2009 by artificially low interest rates, never-ending government borrowing and an unprecedented expansion of our money supply....