Investors in the past several months have become increasingly worried about inflation. That is a real threat to equity prices, as well as the purchasing power of dollars. However, that doesn’t mean investors have no way to benefit. Commodities tend to perform well on an absolute and relative basis during periods of higher inflation, and in this article, we’ll take a look at the case for gold stocks.
We’ll first examine the recent spike in inflation, what that could mean for gold stocks, and three examples of gold stocks we like today.
Inflation, as measured by the Bureau of Labor Statistics, has been on the march higher for all of 2021. The combination of pent-up demand from 2020’s recession, as well as continued shortages in raw materials, labor at factories to produce goods, freight and trucking shortages, and the like, have combined to produce rapidly increasing prices for a wide variety of goods. Energy has been hit with some of the same factors, and as a result, oil and gas prices are much higher than they were a year ago.
All of this means that, all else equal, a dollar has less purchasing power than it did a year ago, and that is generally good for commodities. Within the commodities group, precious metals tend to see not only rising prices from inflation, but additional demand from the safe-haven trade given gold and silver are seen as stores of value.
In short, this means that investor demand for gold in particular tends to rise during inflationary periods as a hedge against rising prices.
The price of gold and other precious metals is denominated in U.S. dollars, so if the U.S. is experiencing inflation, it takes more dollars to buy the same amount of gold. In other words, the price of the asset rises.
Here are three gold stocks we think are well positioned for this to play out:
- Royal Gold (NASDAQ:RGLD)
- Gold Resource Corp. (NYSEAMERICAN:GORO)
- Franco-Nevada Corp. (NYSE:FNV)
Gold Stocks: Royal Gold (RGLD)
Our first stock is Royal Gold, a company that acquires and manages precious metal streams and royalties. Instead of mining physical gold from the ground itself, Royal Gold acquires the rights to the royalties from mines that other companies are physically developing. It primarily generates revenue from gold, silver, copper, nickel, zinc, lead and cobalt.
The company owns interests in almost 200 projects around the world. Royal Gold was founded in 1981, generates about $700 million in annual revenue, and trades with a market capitalization of $7 billion.
We like Royal Gold because it has shown tremendous earnings growth in the past few years, averaging better than 9% annually in the past decade. In the last five years, that number is a staggering 29% off what was a very low base set while metals pricing was relatively low.
Royal Gold benefits tremendously from higher precious metals pricing given its costs are largely fixed. Since it is not mining the metal itself, its right to acquire royalty is already priced up front, so higher prices on the back end when it is time to sell generates additional profit margin. The company has seen strong organic growth due to this operating leverage, and it has been busy acquiring new projects as well. We see 4.5% annual growth going forward from this year’s high base, and we see the company’s impressive 20-year dividend increase streak continuing indefinitely.
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