The best way to profit from Austerity Britain?

I've spent most of the last five years outside the UK and I was a bit shocked on my return.

Strolling down the high street, I noticed something very strange had happened everything had slowed down. On one side of the street, a middle-aged man skulking out of a pawnbroker; and on the other, families milling around the various pound stores and discount shops.

It was as if the high street was crying out "There's no money left here, we're all broke!"

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The press have made a lot of this story in the last two years advising us to buy into pawnbrokers to make a profit. It's as if they're telling us that pawnbrokers are the new high street banks. The likes of H&T and Albemarle have enjoyed a lot of headlines in the last couple of years.

But it's all gone too far. Today I want to explain why the game is up for pawnbrokers. And I will show you what could be a far better way to play austerity in Britain.

How pawnbrokers muscled in on banking

It's easy to see how pawnbrokers have become so popular in the last two years. The banks don't look like they want to do any business - they're literally closing their doors. And in this highly adaptive community, something quickly has to move in to take its place. Right now, that's pawnbrokers.

The National Pawnbrokers Association says that since 2003 pawnbrokers have grown from 500 to 1,300. And that's just the ones registered with the association; the figure doesn't include all the other stores, such as CEX and Cash Converters, that'll buy your second-hand valuables.

This all makes sense. We've just been through a 15-year credit-fuelled consumer boom. Now the high street is reflecting the down-phase. That has been great news for the two main pawnbrokers quoted in London: H&T and Albemarle and Bond. Reports in the press tell us that they are piling on the profits in these austere times.

The National Pawnbrokers Association says "The modern pawnbroker is a cross between a jewellery shop and a building society."

H&T recently released interim results that seem to back it up. At face value the shares look like a steal: profits have shot up and leave the shares trading on a forwards multiple of only 6.8x earnings. Looks cheap huh? But take a closer look.

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The alarms are about to go off

Around half of these stellar profits have come from trading gold. These guys make massive margins from buying cheap scrap gold from punters wanting to cash in Granny's old trinkets. But it looks like this business is already on the wane.

The gold price boom brought with it a boom in punters wanting to cash-in. So H&T set up what's become known as 'gold bars' to mop up demand. These are the stalls you see dotted around the shopping malls emblazoned 'We Buy Gold'.

They set up 56 of these things. But guess what? They've closed 11 of them down since the end of June. It looks like they've had their golden years.

Maybe the public are coming around to the idea that the gold price is going up for a very good reason. So maybe they're keeping hold of their 'hard assets'.

And anyway, this isn't a repeat market. Once Granny's jewellery has been melted down into bullion to feed investor demand, it ain't coming back.

But as an investor, there's a more fundamental issue. And that is: Where have all the profits gone? Let's see.

Mostly they've been eaten up by the cost of setting up new stores (including the gold bars) and paying down debt.

H&T have forecast earnings of 45p per share (the shares are £3.00 as I write), but they're only going to be paying out about 9p of that as a dividend. That's a measly 3% yield and this is during the good times!

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Source: Barclays Stockbrokers

They've still got plenty more debt to pay down, so analysts aren't expecting a significant increase in the dividend.

As for the 'non-gold' business - that's the traditional pawn broking side - margins actually went down.

If the gold price continues to rise (and as I type it's nudging its all-time high), they'll probably conjure some more profits, but it's not a sustainable, and they know it.

A better way to play the gold bull

Gold mining stocks have a lot of potential. Owning gold miners is a bit like owning gold itself. You're betting on the gold reserves that we hope are tucked away safely in the ground.

Better still, if gold is going up, these stocks generally go up even faster. That's because it still costs the same to get the stuff out of the ground, so the extra profits from the gold price drop straight down to the bottom line.

With small speculative miners, things can go wrong, of course. Costs can suddenly escalate, or it may turn out that 'there wasn't any gold in them there hills'. That's why you need to do your homework first.

Dominic Frisby our resident gold Guru - has just produced his latest gold report.

The Gold Profit Plan is a regulated product issued by MoneyWeek Ltd.

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