Investors always need to watch for breakout trends in specific sectors of the market. At the moment, gold stocks are getting a fair amount of well-deserved attention from our analysts.Why should investors consider investing in gold mining stocks? The answer is simple. Quality business ventures are always investment-worthy. The challenge is that investors have to examine the fundamentals of each gold mining company and not get caught up in mere market momentum or hype.
Investment in gold mining stocks tends to gather momentum as the price of gold bullion rises. When bullion prices are high, almost any mining company that can extract a few ounces of gold will make a bit of money. However, when prices fall, there is a reality check and investors often rush to sell all gold stocks. When there is a sell-off, there is little distinction between marginal plays in exploratory companies with "potential" versus producers with multiple locations that are truly well-run gold mining companies.
Iamgold Corp. (TSX-IMG; NYSE-IAG) has been sitting at seventh on Investor's Digest of Canada's list of top-10 'Time to Sells'. However, we expect that this situation is in the process of changing, and investors are advised to monitor this company closely.
Recent reports conclude that Iamgold is an example of a solid company that is going to experience improved returns on the strength of operational improvements and increased gold prices. In a report issued on June 29, Credit Suisse analysts Anita Soni and Robert Reynolds upgraded their rating for the miner from "underperform" to "neutral". They pointed out that the company is turning the corner towards profitability after navigating through a challenging period.
With recent financial results that show a trend towards positive free cash flow and increased earnings before interest, taxes, depreciation, and amortization (EBITDA), Iamgold shares have outperformed the S&P 500 index since April this year. Rising forecast bullion prices are one of the catalysts for Ms. Soni and Mr. Reynolds to increase Iamgold's rating.
There are lots of charts and graphs available on the Internet that claim to evaluate investment trends in gold and the relative value of various gold producers. However, charts can be quite confusing. If multiple charts are reviewed, confusion doubles or triples. Therefore, investors may want to avoid excessively complex assessments and predictive indices that are hard to follow.
Investors in gold stocks should pay attention to three fundamental metrics. First, it is important to calculate the fully loaded cost of production per ounce of gold. A lower cost of production means that even if the commodity price for gold drops, a company can still be profitable. With recently announced improved life-of-mine plans at two mining locations, Iamgold's cost of production is trending downward.
Second, investors ought to evaluate a company's reserves. Using spot gold prices and the current published evaluation of a company's proven reserves, investors can calculate the NAV ratio (net asset value over share price). This metric probes beyond a company's income statement. Instead, the NAV ratio looks at the value of the assets it holds in relation to the share value at a moment in time. Iamgold's NAV ratio looks favourable at gold pricing anywhere above US$1,100 per ounce.
Third, investors should examine the current ratio of price-to-cash flow and compare this to the company's peer group. If the stock price for two companies is $20 per share and one company has a cash flow of $5 per share (20/5=4) and the other company has a cash flow of $10 per share (20/10=2), for example, then using this metric, the company with the lower ratio, (P/CF=2) represents a better value. Among the smaller cap gold stocks, Iamgold presents a favourable price-to-cash flow profile currently.
Ms. Soni and Mr. Reynolds said: "Higher gold prices and a strong balance sheet provides the opportunity to deploy capital and demonstrate management's commitment to improving returns."
For the longer-term investor, gold mining stocks can be part of a balanced portfolio. There will always be price fluctuations and stock market corrections, but the rise in value of well-run gold producers is no flash in the pan!
Investor's Digest of Canada, MPL Communications Inc.133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846