Picking undervalued gold and silver stocks is not a difficult process that requires magical powers. (For the sake of this discussion, I am including silver anytime I mention gold.) There are many tools that are available to us that can make the whole process relatively simple. Once you get that “gut” feeling that you are onto a good undervalued gold stock, all you have to do is look through the company’s financials and the evidence is pretty much all there for you to determine whether the stock is truly undervalued or not.
There can be variables that might cause the stock to under perform in the future, but in general, if the financials are sound and the company has assets in the ground, you will do well once the gold boom resumes in the very near future.
Before we take a look at some of the tools that are available to us, I want to bring up two points that make the case for why this bull market in gold is just getting started. If you are going to be looking for undervalued gold stocks, you need to know that the underlying value of the metal in the ground is going to rise going forward.
The Case For Rising Gold Prices
The first is inflation and the second is a very important recent piece in the Wall Street Journal. Since the 2008 near financial collapse the Fed has put the printing presses into hyper-drive and combine that with a President that has piled up more debt in the last three years than all of his predecessors combined before him, and there should be no doubt that inflation is getting ready to roar. We are already seeing it in food costs and everything we purchase that requires energy to make or ship. This trend will only accelerate, unless we have a drastic change in course, which does not look likely considering the current political environment in America.
If you were to value gold in 1980 dollars, $1,500 gold price would equate roughly to $3600 per ounce. That figure is startling, but it is simply an inflation adjusted number and does not represent any of the other factors that go into the makeup of the price of gold. Gold at$5,00o per ounce may be a very conservative number as this gold bull matures.
The second important indicator is the Wall Street Journal article by Julie Crawshaw and Forrest Jones published on Wednesday, 28 Mar 2012 which outlines an alarming trend that does not bode well for the value of the U.S. dollar. There is now no question that foreign buyers have backed away from the dollar and the only thing keeping interest rates low is the intervention in the currency markets that the Fed has been implementing since the beginning of the 2008 financial crisis. The Fed’s stated intent of keep interest rates near zero through 2014 is a recipe for a declining dollar that will lead to the dollar being replaced as the world’s reserve currency! Can you say Renminbi?
WSJ: Fed Buying 61 Percent of US DebtWednesday, 28 Mar 2012 11:08 AM
By Julie Crawshaw and Forrest JonesThe Federal Reserve is propping up the entire U.S. economy by buying 61 percent of the government debt issued by the Treasury Department, a trend that cannot last, Lawrence Goodman, a former Treasury official and current president of the Center for Financial Stability, writes in a Wall Street Journal opinion article published Wednesday.
“Last year the Fed purchased a stunning 61 percent of the total net Treasury issuance, up from negligible amounts prior to the 2008 financial crisis,” Goodman writes.
Goodman also warns that U.S. economy and markets are “at risk for a sharp correction” if conditions aren’t “normalized.”
“This not only creates the false appearance of limitless demand for U.S. debt but also blunts any sense of urgency to reduce super-sized budget deficits.”
The article continues with this telling bit regarding the foreign demand for U.S. debt.
Fed intervention in the government debt market makes demand for Treasury bonds appear higher than it really is, as foreign creditors and other investors have fled U.S. government debt instruments and are looking elsewhere until the government makes serious attempts to curb spending and narrow its gaping deficits.
Goodman notes that foreign investors like Japan and China that once scooped up U.S. debt are shunning it. In 2009, such foreign purchases of U.S. debt amounted to 6 percent of GDP and has since fallen by over eighty percent to a paltry 0.9 percent.
To see the entire article, go to http://www.moneynews.com/Headline/fed-debt-Treasury/2012/03/28/id/434106
OK, we know that gold is going to be going up in value, so lets look at some of the tools that you can use to help you find undervalued gold stocks.
Tools For Picking Undervalued Metals Stocks
The following are some very easy to use tools that can help any investor, from the novice to the experienced, to determine whether the stock that they are looking at is overvalued or undervalued.
Price to Book
A stock’s book value is the company’s total assets minus it’s total liability’s. In other words, it is the worth of the company once all of its obligations are met. In most cases this value is represented in its per share value. In some cases there are other factors that can effect the company’s share price that don’t represent the price to book value.
An example would be mining company “A” that had assets of $100 million and liabilities of just $1 million, but was about to have its assets nationalized in a foreign country. The potential loss of those assets would be reflected in the share price even though the price to book looked exceptional.
When a stock has a book value of $5, it could be undervalued if it is trading at $2 a share, but it would not be undervalued if it was trading at $8 per share. If everything is on the up and up and there are no hidden problems with the company, the lower the price to book, the better.
Price to Earnings, or P/E Ratio
The price to earnings, or P/E ratio represents the relationship between a company’s share price as it relates to its per-share earnings. As a broad generalization, a low P/E ratio can indicate that the stock is undervalued.
The earnings per share, or EPS, is most often taken from the last four quarterly reports and is often referred as the trailing P/E. In some instances, it can be taken from estimates of earnings that are expected in the next four quarters and when that is the case, it is called a projected,or forward P/E.
A high P/E normally suggests that investors are expecting higher earnings growth going forward whereas a lower P/E indicates that they are expecting lower earnings in the future. It is important to note that the P/E ratio tells us what investors are “feeling” about a particular stock as demonstrated by what investors are willing to pay for the company’s shares.
When comparing P/E ratios, you have to stay in the same category of stocks. It does no good to compare mining stock P/E’s with technology stock P/E’s. Comparing P/E’s in the same industry can give you a snapshot of what investors are thinking about stocks in that category. You can also gauge changing sentiment by comparing a company’s historical P/E ratio with its current ratio.
The current ratio is the ratio that is determined by a company’s current assets divided by its current liabilities. When looking at the current ratio, the higher the ratio, the better.
The ratio is mostly used to show a company’s ability to pay back its short-term liabilities with its short-term cash. A higher current ratio, indicates that the company is capable of paying its short term obligations with its short term receivables. A really low ratio suggests that the company would be unable to pay off its obligations if they came while their current ratio was low. A low ratio points towards a company that is not in good financial health. It does not necessarily mean that the company is in dire financial straits, but it is a warning flag that caution should be exercised when considering the company.
There are many reasons for low trading volume, but in general, stocks with low trading volume are either out of favor with traders, or they have not even made it on most investor’s radar screens. Stocks with high trading values have already been discovered by the market and institutional investors. When trading volume increases, stocks tend to move towards their fair valuation, and that can be either up or down depending on the reasons prompting the increased trading volume.
Low Debt To Equity Ratio
This may be the most important bit of advice that you may ever get when it comes to investing in any type of company. Be sure when you invest that you are investing in companies that generate income, not debt. Debt is a warning sign that all investors should be aware of. The larger the debt level, the harder it will be for the company to maintain its viability when market conditions change, such as with a correction in the price of gold.
We have seen how the gold and silver miners have struggled as gold and silver consolidated during the past couple of months. Make sure that you pick stocks that generate cash and not debt if you want to survive the even more violent corrections that are certain to come as gold moves to $2,000 and beyond.
Add these tools to your investing tool box and you will be ready to find truly undervalued gold stocks as gold continues meandering along in the current trading range before its next upward leg. Take the time to explore these tools and understand them because the “experts’ are beginning to call the end of the gold bull run, which is a sure sign that the next leg up is not far off!
Till next time, good luck and good trading!
More Gold Market Analysis:
- Three Undervalued Gold/Silver Stocks
- Goldcorp Stumbles
- Four Mining Stocks To Consider While “There Is Blood In The Streets!”
- Gold Undervalued?
- Cliffs Natural Resources