Conclusion
Gold mining stocks provide dynamic exposure to rising metal prices, but frequently with a lag. If one believes that the current gold price is sustainable, the historically high discount between the shares and the metal represents a compelling opportunity. The industry, once marginal, is now on solid footing with durable free cash flow. With more enlightened management, decisions on the deployment of free cash ought to result in substantial dividend increases. Mainstream investors agnostic on the prospects for monetary debasement may well come to regard gold stocks as generic yield plays. Quoting Jim Sinclair: "gold stocks are the utilities of the future."
Still ahead is the possibility that gold will be reintegrated into the international monetary system. Should desperate governments grasp at this straw, they will have to fix the price of gold at a level sufficiently high for investors to prefer government paper to the metal. While it is hard to imagine a repeat of the Roosevelt administration's confiscation of gold from U.S. citizens on a global scale, it is worth recalling that gold mining stocks benefitted while those who dutifully turned in their coins and bullion did not:
The case for the sustainability of high gold prices rests on whether the present international system of money and banking has passed a point of no return. If Western political leaders and policy makers prove unable to restore credibility to the financial model of the democratic welfare state, a permanent devaluation of paper money against gold will be unavoidable, whether it takes the form of high inflation or a resumption of the gold standard. Either outcome implies political and social changes not currently imagined by the financial markets.
For gold mining equities, the valuation implications would be profound. Resulting earnings would, in our opinion, be supported by permanent, not cyclical change. Multiples of earnings and cash flow would not assume a reversion of the business cycle from peak to trough but on a new international order of credit and banking. For acrophobic investors, paralyzed by the steep advance in the gold price, we believe gold mining equities offer a safety net of valuation and mispriced optionality. It is a second chance well worth taking.
John Hathaway is manager of the Tocqueville Gold Fund (TGLDX).