Gold and Biotech: How Similar Are They? And Which to Buy Now?

Eric Fry By Eric Fry, Macro Strategist, The Oxford Club

Metals

Gold stocks and biotech stocks aren’t very much alike, but they aren’t entirely unalike either.

That’s why it’s fun to compare them to each other from time to time. The comparison can yield a helpful insight or two, but that’s not guaranteed.

Fun first, insight second… That’s the goal of this exercise.

On the surface, gold stocks and biotech stocks are very different from each other…

But upon closer examination, they look a lot like flip sides of the same coin.

Both offer the prospect of making a big discovery and “striking it rich.” Unfortunately, grand successes in either sector are rare. Disappointments are common.

Nevertheless, just the possibility of a grand success causes folks to sink dollars into all kinds of companies – good and bad alike. Enthusiasm leads to excitement, which leads to excess, causing stock valuations to reach frothy, dangerous levels.

But eventually, the cycle turns. The high-flying stocks that could do no wrong become low-flying stocks that can do no right. This boom-bust cycle can be particularly painful in sectors that are as prone to speculation as gold and biotech.

They should probably come with a warning label that says something like…

BEWARE OF PROLONGED EXPOSURE. POSSIBLE SIDE EFFECTS INCLUDE SUDDEN LOSS OF CAPITAL.

Mark Twain is believed to have described a gold mine as a “hole in the ground with a liar standing next to it.”

That’s not unlike the biotech sector, full of folks in lab coats standing next to a drug therapy that will never make it out of clinical trials… or even into clinical trials.

The folks in the lab coats aren’t liars, of course; they’re hardworking scientists who huddle over their test tubes as tirelessly as a forty-niner panning for gold. But it’s not easy to bring a new drug to market.

Only one in 1,000 drugs that enter preclinical trials progresses to human trials, according to the Pharmaceutical Research and Manufacturers of America. And then, only one of the five drugs that proceeds through human trials ultimately gains FDA approval and makes it to pharmacy shelves.

In other words, betting on a promising new biotech therapy is a 5,000-to-1 shot.

Those aren’t great odds.

As for the cost of bringing a biotech drug to market, the Tufts Center for the Study of Drug Development pegs the price tag of developing a prescription drug that gains market approval at $2.6 billion.

Clearly, it is neither easy nor cheap to make dreams come true in the biotech sector. So if the sector can’t make enough dreams come true, the sector in aggregate can become very expensive very quickly.

The gold sector is similar. Sometimes hope outruns substance, and gold stocks as a group become richly valued. That’s exactly what happened in 2011. As the gold price rose from its 2008 lows to a new all-time high above $1,900 an ounce, the VanEck Vectors Gold Miners ETF (NYSE: GDX) doubled… then tripled… then nearly quadrupled.

The sector had become a bit frothy, and the reversal from those levels was utterly brutal. The fund tumbled 80% over the next four years.

But gold stocks and biotech stocks do not go through their manic-depressive cycles at the same time. In fact, they tend to move in opposite directions. As gold stocks were tumbling from their 2011 highs, for example, biotech stocks were starting a spectacular climb that would see the Nasdaq Biotechnology Index soar 400% over the ensuing four years.

That’s why a quick-and-dirty comparison between the two sectors can sometimes yield a helpful insight… or at least an intriguing one.

Two years ago, for example, I observed that the Nasdaq Biotech Index had become a much more expensive speculation than the PHLX Gold/Silver Sector Index. Therefore, I suggested selling biotech stocks and buying gold stocks.

That suggestion turned out to be a good one, as the Gold Sector Index has soared 86% since then, while the Nasdaq Biotech Index has advanced only 10%…

Given the Gold Sector Index’s strong performance over the last two years, you would expect gold stocks to have become more expensive than biotech stocks. But that’s not the case. Biotech stocks are still much more expensive by any valuation metric you care to use.

That’s because the gold sector’s earnings have been rising, while the biotech sector’s earnings have been falling.

The chart below tells the tale. It shows the recent earnings before interest, taxes, depreciation and amortization (EBITDA or gross earnings) trend of the VanEck Gold Miners ETF compared with those of the SPDR S&P Biotech ETF (NYSE: XBI)…

Based on these numbers, the VanEck Gold Miners ETF is selling for less than eight times EBITDA, whereas the S&P Biotech ETF is selling for infinity times EBITDA… since its EBITDA is negative.

Clearly, the biotech sector is offering pricey speculation relative to the gold mining sector. So I’ll double down on a recommendation I made two years ago…

Sell biotech ETFs; buy gold ETFs.

But remember, we’re talking about speculations. So even though I consider gold stocks to be the superior speculation at the moment, I would add the same warning label I proposed two years ago…

Gold stocks can subject investors to a long list of potential side effects. In some cases, owning gold stocks can cause nausea, indigestion, sleeplessness, irritability, marital strife, alcoholism, depression and suicidal thoughts.

Be sure to alert your financial advisor about a depression lasting longer than four hours.

Good investing,

Eric

P.S. Even though I believe the biotech sector, in aggregate, is a sell, certain stocks in the sector will deliver enormous gains. In fact, I doubt any sector will produce more huge winners over the next decade than the biotech sector.

But it will also remain a high-stakes sector where failure is much more common than success…

That’s why I admire individuals like my colleague Marc Lichtenfeld, editor of Lightning Trend Trader, who has a talent for identifying the elite biotech companies than can become breakthrough success stories. To learn more, click here.