By Andrey Dashkov, analyst, Casey Research
Gold has been on a lot of people’s minds throughout this crisis… because gold is a safe-haven asset. And at Casey Research, we encourage always having gold exposure in your portfolio (and some physical metal, as well).
Lately, investors have been concerned about the performance of their gold holdings during this pandemic. But let me assure you… gold as disaster insurance is still working as it should.
Check out this chart of the S&P 500 versus the gold price year-to-date:
The gold price dropped 13%… while the S&P dropped a painful 36%. I know which drop I prefer.
Now, gold mining stocks have also been hit hard.
But I’ll show you why they’re still a great play right now…
Gold Stocks in Action
When you buy a gold stock, you expect that it will outperform the metal itself. You want its share price chart to look like this:
Company X is a real company – in fact, it’s a holding in our International Speculator newsletter, headed up by geologist and commodities expert Dave Forest. Company X’s price swung up and down more than that of gold… and that’s how high leverage looks in practice.
But what is leverage? Glad you asked…
When we talk about leverage, we mean a performance boost. For example, when gold goes up, gold miners leveraged to its price go up more.
When the price slides, gold miners slide more.
Whatever the price does, gold mining stocks do more of it.
This is why Company X is up 32% over the previous year while gold is up 23%. This 9-point outperformance is what high leverage looks like.
This difference was even higher before the current crisis. On February 21, Company X was up 78%, 51 percentage points ahead of gold.
A lot of the time, though, what you see is this:
Though things may turn around for OceanaGold, that’s an ugly chart. The good news is, we don’t hold OceanaGold in any of our Casey Research portfolios.
But we do hold quite a few gold stocks across our various publications.
So how do we pick winners like the first chart? There are three big factors that make up my triple leverage strategy: Price leverage… Performance leverage… and People leverage.
You need a solid mix of all three to pinpoint a winning stock.
With this, let’s see how you can increase your gold leverage and make more money investing in gold stocks.
Factor 1: Price Leverage
Price leverage looks like the first chart I showed you: A company’s share price moves more than gold.
But a picture isn’t enough. As an analyst, I like to put a number on everything. This is why I also look at the “gold beta.”
The gold beta is a number that tells you how related, historically, a company’s share price has been to the price of gold.
If, over time, a company’s share price grew by 2% when the price of gold grew only 1%, and the relationship has held up, the stock’s “gold beta” would be high.
So I researched gold miners, and selected those with the highest “gold betas.” Sure enough, most of them performed better than gold.
But that’s not deep enough.
There’s no single number in any industry that tells the whole story…
Factor 2: Performance Leverage
So we have to look at fundamentals, as well. While the “gold beta” is all about share price, we need to look at what drives it: the mining business and its economics.
To find the most fundamentally leveraged gold companies, I looked at gold producers with high cash costs – $600 or higher.
Cash costs are the direct expenses mining companies need to produce an ounce of gold.
I used $600 to filter out the low-cost producers who don’t have this kind of leverage. Their income won’t change as much when the gold price rises or falls compared to that of the high-cost companies.
To simplify, the companies with the highest costs – and the slimmest margins – should respond the best to a rising gold price. If gold price grows by 10%, a company with high operating leverage would see its income grow by, say, 15%.
One way to select companies with high performance leverage is to look at the ones with high cash costs. Their margins are slim now, but should improve faster than sales if gold price rises.
So that’s what I did. Among the stocks I screened for, I selected the ones with 2019 cash costs of $600 or higher.
I ended up with about 30 stocks.
But there’s one critical element that I haven’t talked about yet…
Factor 3: “People” Leverage
Casey Research founder Doug Casey puts his stock picks through a rigorous test with nine criteria… And “People” is the first factor he looks at in his company analysis – and deservedly so.
If a company doesn’t have the right people at the helm, it’s not worth looking at.
And these people should have proper incentives to make a company work. In other words, they should be rewarded for their achievements.
Stock ownership is one of the best ways to make that happen. The more value the company generates for its shareholders, the more money its management makes. It’s a win-win.
That’s why I looked for gold miners with teams that own a high percentage of the company’s stock.
But not all companies have high management ownership. In other words, quite a few management teams don’t have enough incentive to do their best work.
So I made sure to pick the companies with the highest management ownership, as reported by Capital IQ.
This was the final element of my “triple leverage” approach.
Here’s what I found…
Putting it All Together
Two companies stood out from the rest of the pack when it comes to leverage… and unsurprisingly, they’re both holdings in Casey Research newsletters…
Company X (again, a holding in International Speculator), and a holding in our Strategic Investor newsletter… we’ll call it Company Z.
Even though they didn’t get the highest scores in each group, overall they looked strong.
And, unsurprisingly, their price charts reflect that:
Both outperformed gold (the blue line in the chart) in 2019, and so far in 2020 – by a wide margin. Company X is ahead of gold by 9 percentage points, and Company Z is ahead by 14 percentage points.
Now is a good time to look at gold mining stocks. If you want an easy, one-click way to gain exposure, check out the VanEck Vectors Gold Miners ETF (GDX). It holds a basket of gold stocks… just keep in mind not all of the holdings pass my triple leverage test.
But when the current turmoil eventually ends, gold mining stocks – especially those that pass my triple leverage test – will be poised to deliver explosive gains.
Analyst, Casey Research
P.S. My colleague Dave Forest has a host of winning gold stocks in his International Speculator portfolio… and even in the current drawdown, he’s seeing gains like 150%… 57%… and even a 37% gain in less than two weeks.
It’s because he has one more exclusive edge when it comes to picking winning gold stocks… it’s almost unfair.
He has access to a NASA satellite – and an exclusive algorithm – that helps him find gold from space.
See how you can take advantage of it right here.