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You Rode the Tesla Wave, Here's Why You Should Consider Gold Stocks

Elon Musk of Tesla Inc (NASDAQ: TSLA) thinks big...very big. If you've benefited from this man's genius, riding the wave higher and higher, congratulations. But it's time to start thinking about protecting some of those gains before a mood shift on Wall Street washes them away. Here's why you should consider putting some of your Tesla gains into gold stocks like Royal Gold, Inc (NASDAQ: RGLD) and Franco-Nevada Corp (NYSE: FNV)

It's not you, it's your valuation

I'm not going to bash Tesla as a company. The fact is, the automaker has a great product. And the CEO, Musk, is truly a visionary thinker. He's inspired millions of loyal followers. There are negatives worth noting, including a heavy debt load and all the cash the company is burning through right now as it works to bring out a new electric car to address the mass market. But let's forget about those and focus on valuation.  

Image source: Getty Images.

Tesla doesn't have earnings, meaning its PE is infinite. So, you can't compare its value using that metric. It does have sales, though, so you can use its price-to-sales ratio as a valuation tool. Only when you use price to sales, the valuation comparison is kind of frightening.

For example, the company's current price-to-sales ratio is 6.6. That's actually down from a five-year average of 11.6, so you might say its valuation is getting better. However, its auto industry peers have price-to-sales ratios in the 0.5 range. In fact, no major automaker has a price-to-sales ratio above 1. The S&P 500, which some suggest is currently at unsustainable peaks, has a price-to-sales ratio of about 2.1 -- Tesla is more than three times more expensive than an expensive market!    

Gold Price in US Dollars data by YCharts.

If you have ridden the Tesla wave, you should really be thinking about taking some profits and putting them into something that can protect you from volatility. Some of the best assets for that are gold and gold mining stocks. When the going gets tough on Wall Street, gold tends to become a much more desirable asset. The price of gold during the 2007 to 2009 recession (see the above chart) is solid evidence of this.

Two options to consider

You can get gold into your portfolio in a few different ways. You could buy bullion, but that would require you to store it and likely pay a large markup on the coins. You can buy exchange-traded funds, which is an easier option. Or you could buy a gold stock, which would be my choice. Two of my favorites are Royal Gold and Franco-Nevada. These are precious metals companies, but not miners.

What they do is called streaming. Essentially, they give money up front to miners in exchange for the right to buy gold and silver at reduced prices in the future. Miners use the cash to shore up balance sheets, build new mines, or expand existing assets. It gives them another way to finance their businesses when other options, like banks and tapping the capital markets, aren't desirable.

Streaming companies like these deals because it locks in low rates. To give you an example, Royal Gold inked a deal with gold mining giant Barrick Gold (NYSE: ABX) in 2015. Barrick got $610 million, and Royal Gold got the right to buy gold and silver from the Pueblo Viejo mine, one of the largest gold mines in the world, at 30% of spot prices up to certain production levels, and then 60% of spot thereafter. That locks in huge margins for Royal Gold.  

Here's another reason to like this pair: dividends. If you own Tesla, dividends may not matter to you, but with yields of around 1.2%, income isn't going to get you rich at Royal Gold or Franco-Nevada. What's so impressive about this pair's dividends is that they've grown year in and year out. Franco-Nevada's streak of consecutive annual dividend increases is set to hit 10 years this year, and Royal Gold's record is up to 16 years. Commodities like gold have been weak since about 2011; the dividend records here are best seen as an example of the resilience of the streaming business model.  

Gold Price in US Dollars data by YCharts.

Take a look at what happened to Royal Gold and Franco-Nevada during the last recession. Gold did well relative to the market, and Royal Gold and Franco-Nevada did even better. Of course, past performance is no guarantee of future returns, we all know that, but these two gold stocks have proven they have staying power (those dividend hikes), and they get you exposure to an asset (gold) that has historically held up well during the worst of times.

It's going to happen

Tesla's stock is up a massive 70% so far this year. It could be the best company in the world, but that doesn't mean the stock can keep a run like that going forever. At some point, Tesla stock will come back down to earth. When that happens, you'll be happy if you take some money off the table and stash it in a company, like Royal Gold or Franco-Nevada, that tends to move a little differently than the broader market. If you've ridden the Tesla wave, now is the time to start thinking about investing some of your gains in gold stocks.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Tesla. The Motley Fool has a disclosure policy.