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.
Gold Resource Corp. (GORO)
Next up is Gold Resource Corp., a company that explores for, develops, produces and sells gold and silver in Mexico and the U.S. To a lesser extent, the company also generates revenue from copper, lead and zinc. Gold Resource’s primary project is Aguila, which has 18 mining concessions in Oaxaca, Mexico.
Gold Resource was founded in 1998, generates about $120 million in annual revenue, and trades with a market capitalization of $170 million.
Gold Resource recently spun off its mining unit in Nevada, and is consequently solely focused on its operation in Oaxaca. Unfortunately, Gold Resource’s track record isn’t very strong, as it has seen earnings and indeed the share price fall sharply in the past decade.
However, we see strong earnings growth potential from this year’s low base, which we see as accruing from higher precious metals pricing, as well as production growth. Both of these should drive the top line higher and consequently, profits as well as the company experiences operating leverage over time.
Gold Stocks: Franco-Nevada Corp. (FNV)
Our final stock is Franco-Nevada Corp. a gold-focused royalty and streaming company that operates in the U.S., Latin America, Canada, Australia, Africa and Europe. Franco-Nevada operates in both mining and energy markets, with end products including gold, silver, platinum, oil, gas and natural gas liquids. The company was founded in 2007, generates about $1.3 billion in annual revenue, and trades with a whopping $29 billion market capitalization.
We expect solid 6.5% annual earnings growth for Franco-Nevada, which would come off of what should be record earnings for 2021. Like the others, Franco-Nevada produces a huge amount of operating leverage when end market prices are strong for metals, as they have been of late. It has a pipeline of new metals and gas royalties to grow the top line via higher volumes.
The company’s average growth rate over the past decade is in excess of 10%, so we see 6.5% as highly achievable, particularly if inflation does continue and we see persistently high metals and energy pricing. We like Franco-Nevada because it stands to benefit from two completely separate asset classes, both of which should do well in an inflationary environment.
Final Thoughts
While inflation has many negative impacts on investors, as well as consumers in their daily purchases, it can be a boon for certain sectors. We see precious metals companies as having the potential to reap significant benefits from an inflationary environment as pricing and demand for gold, in particular, should rise during such a period.
We’ve named three companies we like in the sector that all have reasonable valuations, strong growth prospects and pay dividends to shareholders. While precious metals companies carry with them their own set of risks, in environments such as the one we’re in today, they tend to do quite well and we see them as strong inflation hedges for investors.
On the date of publication, Bob Ciura did not have (either directly or indirectly) positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Bob Ciura has worked at Sure Dividend since 2016. He oversees all content for Sure Dividend and its partner sites. Prior to joining Sure Dividend, Bob was an independent equity analyst. His articles have been published on major financial websites such as The Motley Fool, Seeking Alpha, Business Insider and more. Bob received a bachelor’s degree in Finance from DePaul University and an MBA with a concentration in investments from the University of Notre Dame.