Are Gold-Mining Stocks The Best Way To Bet On Inflation?

Gold-mining stocks may be the most attractive way for investors to boost their stake in gold, especially if they are concerned about inflation.

Investing profitably is not simply a matter of picking an attractive asset -- the asset must also be purchased at an attractive price.

Gold itself, in this context, may have become too expensive because many investors have already flocked to this trade.

The investment thesis for gold is simple: Western central banks have printed trillions of dollars in multiple paper currencies during the past few years, so the prices of hard assets such as gold must rise.

Moreover, gold has historically acted as a quasicurrency that has preserved some purchasing power when unstable fiat currencies have collapsed.

However, the price of gold has almost doubled since 2008, and it may already reflect the effect of future inflation, which limits its upside potential once inflation actually hits.

Meanwhile, the prices of gold-mining stocks have lagged behind that of the yellow metal. For example, the Market Vectors Gold Miners ETF (NYSEARCA: GDX) -- an exchange-traded fund that tracks the the price and yield performance of the NYSE Arca Gold Miners Index whose components are primarily large-capitalization gold-mining stocks -- has risen only about 9.89 percent since the beginning of 2008.

One reason gold-mining stocks have lagged the precious metal itself is the introduction of gold ETFs, such as the SPDR Gold Shares (NYSEARCA: GLD), in recent years.

Previously, institutional investors wanting to avoid the hassle of owning physical gold or constantly rolling over gold futures contracts opted for gold-mining stocks like the Newmont Mining Corp. (NYSE: NEM), according to financial writer Brett Arends at SmartMoney.

Now, gold ETFs are available to meet this demand, and gold miners have become cheap relative to the yellow metal itself.

The price-to-earnings ratios of these stocks are also low by historic standards. Newmont’s most recent P/E ratio was distorted by a large noncash write-down.

Gregory Zuckerman and Liam Pleven pointed out at WSJ.com that gold-mining stocks may be cheap for a reason as investors may be worried about rising mining costs and the threat of higher royalties and taxes on natural-resource companies.

However, these worries have arguably loomed over gold miners for a long time, while low valuations -- relative to earnings and the price of gold -- have not always presented themselves as attractively as they are now.

At least two famed value investors have flocked to gold-mining stocks:

-- Seth Klarman’s Baupost Group, which manages about $24 billion, has holdings in the Allied Nevada Gold Corp. (NYSEAMEX: ANV) and NovaGold Resources Inc. (NYSEAMEX: NG).

-- David Einhorn’s Greenlight Capital, which manages about $5 billion, has holdings in the Barrick Gold Corp. (NYSE: ABX) and Market Vectors Gold Miners ETF.

Late Friday afternoon, gold futures were up 1.30 percent. Gold miners fared slightly better, with Barrick Gold closing up 1.58 percent and Newmont Mining closing up 1.74 percent.

Besides gold miners, Klarman has pointed to out-of-the-money put options on long-term U.S. Treasurys, which profit if Treasury prices drop, as another attractive inflation hedge.

However, inflation-linked government bonds, a favorite among institutional investors as hedges against inflation, have become “unprecedentedly expensive,” in the opinion of Jonathan Ruffer, a hedge-fund manager in the United Kingdom.