Gold Mining Stocks Investor Guide
Gold is an excellent way to diversify your portfolio. It's also a great hedge against inflation and currency risk. There are two primary ways to invest in gold. You can invest in physical gold (which you can store yourself or at a depository), paper gold (gold ETFs, gold futures, and options).
Paper gold offers investors the ability to trade without having physical possession of the metal, which means they don't have to worry about storage costs or safety issues. Plus, it's easy to buy and sell with just one click.
In this article, we will only discuss gold mining stocks. Where do they stand as a type of gold investment? Is investing in gold mining stocks the same as investing in physical gold? Or are there any intricacies you should be aware of?
We will respond to all of these questions.
What is a gold mining stock?
Gold mining stocks are the company stocks of gold mining companies. When you buy a gold stock, you are investing in the stock of a gold mining company. The performance of gold stock is primarily determined by the gold price and the company's expected performance.
Investing in gold mining companies consider factors like management team, production costs, reserves, mine exploration, project growth, and hedging activities. Therefore, gold mining stocks is a hybrid type of investment that takes into account many factors.
The stock market performs poorly when the economy is bad. During those times, precious metals usually do well. Because the government prints money during a bad economy, inflation tends to rise.
Investors believe precious metals are a good inflation hedge, especially during difficult times. Because they are not printable and are only available in a limited quantity at any given time.
What about gold mining stocks?
A type of hybrid investment that functions as a company stock while hedging against inflation using gold metal. How could that perform both when the economy is doing well and when it is not?
We'll take a closer look at that.
What to look for investing in gold mining stocks?
You have two main questions to answer as a gold mining stock investor.
- How do you think gold will perform in the future?
- What is the likelihood of the gold mining company you intend to invest in performing well in the future?
There are only two questions to which you must respond. Isn't it supposed to be easy to make money investing in gold mining stocks?
You're wrong! There are many more factors that go into the evaluation, making it extremely difficult to take a position.
As I have previously stated, the stock market and precious metals move in opposite directions. Most investors make this assumption. However, that isn't always the case.
There have been times when the stock market and precious metals have moved in parallel. This fact alone makes the puzzle more difficult to solve.
Are gold ETFs and gold mining stocks the same thing?
Gold ETFs and gold mining stocks have some similarities. However, gold ETFs refer to a broader range of investment options.
Gold ETFs are a type of investment vehicle that is traded on the stock market. While gold mining stocks represent ownership in gold mines and companies engaged primarily with extracting ore from earth to produce bullion or other precious metals like gold and silver for sale as raw materials.
Gold ETFs allow investors to purchase a basket of gold mining companies involved in the exploration and production of gold mines, as well as the production of gold from those mines.
There are currently a number of gold ETFs available that include exposure to physical gold stored in massive vaults. Buying a share of such an ETF is the same as going to your local bullion dealer and buying gold yourself.
While investing in a physical gold ETF is simple: if the price of gold rises, you profit; if it falls, you lose money, investing in a gold mining ETF is much more complicated.
To begin, an ETF that includes a basket of gold mining companies is buying a basket of individual stocks. This can be both a good and a bad thing.
Even if the gold price rises, gold mining companies may suffer if the stock market. The inverse is also possible, mining companies may appreciate in value while the gold price falls.
In general, there is a strong long-term correlation between the value of mining companies and gold prices. Keep in mind, however, that it is not uncommon for the two to differ significantly in shorter time frames.
Profitability is the next distinguishing factor for mining companies. Because the primary goal of a mining company is to maximize profits for its shareholders. Profitability would depend on mining production, cost structure, and other factors, such as:
Mining companies can hedge their production (lock in a fixed price), ensuring consistent profits. However, by hedging, the producer does not benefit from any increase in gold prices and, conversely, suffers from any decrease in prices.
Management has a significant impact on profitability. Good executives can help a miner stay profitable even when prices are at an all-time high, whereas bad executives can waste a company's income even when prices are at an all-time high.
One of the most disadvantageous aspects of gold investing is that it does not pay dividends to its investors. Although this is true for the metal itself, gold mining companies, particularly the larger ones, pay dividends on which an ETF investor can profit.
When all is considered, it is clear that an investment in gold mining companies is not exactly the same as in investing in gold ETFs.
How does gold price affect gold mining stocks?
The product of a gold mining company is the gold it has mined. As gold prices rise, these companies will make more money. There's no doubt about it. Similarly, if gold does not perform well, these companies will not make much money.
Some mining companies may have more resources and choose not to exchange their gold if they believe gold will appreciate in the future.
However, this is not applicable to most mining companies. Because these companies should pay for their expenses in dollars, or whatever the currency applicable in the nation they operate.
Therefore, it is safe to say, with gold prices move up, the profitability of the gold mining business grows.
How do gold mining companies work?
If you want to invest in gold mining stocks, you need to have an idea about the business model of these companies. You should know the dynamics of the industry, let alone the specifics of the individual company you choose.
As the legendary investor Warren Buffet said:
Gold is present everywhere on Earth, but it is rarely found in large quantities. Because of the nature of gold mining, you will find companies of all shapes and sizes to include in your portfolio.
Some mining companies depend solely on a single mine as their primary source of revenue.
Investing in these companies can be profitable if that particular mine performs much better than investors predicted.
However, it also exposes the business to massive risks. If anything bad occurs like a labor strike or an accident, these conditions are likely to slow down the mining operations and as a result, diminishes production and profitability.
Investing in these types of large-cap mining companies your capital has less growth potential. However, they are safer than smaller cap companies that solely depend on a single mine operation area.
Conservative investors should better stick to larger gold mining companies' stocks since these companies are better hedged to risks we will mention further.
Mining companies mine other metals
Most gold mining companies mine other metals other than gold. Companies almost often discover other valuable resources in the ore that they mine as a natural byproduct of the gold mining process.
It's not uncommon to see silver, copper, and other base metals extracted besides the gold from a gold mine.
However, some mining companies derive a significant portion of their income from metals apart from gold.
There's nothing particularly wrong with that, but if your primary objective is to profit from positive gold market conditions, you may want to avoid additional exposure to metals other than gold.
However, a company that mines multiple varieties of metals might be a good option if you like the premise of diversification beyond gold.
A few examples can demonstrate how wide the array can be. Freeport-McMoRan (NYSE: FCX) mines a lot of gold, but the company is better known for being a copper miner since it owns the Grasberg mine in Indonesia, which has one of the world's largest copper and gold reserves.
Since the global economy hasn't seen the intensity that it did during the commodity market's long boom, the copper sector has played an important role in keeping Freeport's returns down over the last few years.
As a result, even as gold prices have risen, Freeport has had to contend with pressure from the copper side of its market, much to the annoyance of those who bought the stock believing they were having more exposure to gold.
Sibanye-Stillwater (NYSE: SBSW), on the other hand, has grown from its multiple exposures to gold and platinum metals. Sibanye already had significant platinum and palladium assets until purchasing Montana's Stillwater Mining in 2017,
However, Stillwater's emphasis on platinum group metals allowed the company an even more important focus for the merged business.
Although palladium prices have surged, even surpassing the price of gold, and Sibanye-Stillwater has profited handsomely as a result. There's no certainty, though, that the prices of gold, platinum, and palladium will have some relationship in the future.
Therefore, before you choose a specific gold mining stock, you must decide how much of gold exposure your investment should have.
Countries where mining operations are riskier
Mining gold has different level of risks depending on which country the mine is.
For example, South Africa has abundant natural resources, making it one of the most common locations for gold mining companies to operate.
However, the country has experienced economic problems that differ from those seen in other countries with large gold reserves, such as the United States, Canada, and Australia.
As a result, South African gold mining companies face political risks that they don't face in other developed countries.
Investing in South African mines, in particular, exposes you to the risk of operating in an economy that is highly dependent on natural resources. This is good when commodity prices are stable, but the intense volatility in the gold market and other main commodities has caused chaos on the South African economy.
Mining companies in the nation are now regularly subjected to labor strikes and government control, and the increasing costs of doing business in South Africa have prompted some companies to consider leaving the country.
AngloGold Ashanti (NYSE: AU), for example, has considered withdrawing all of its South African assets in order to concentrate on mining resources in other areas of Africa, and also in South America and Australia.
For a South African nation to undertake such a move is a bold step, but it illustrates how much confusion remains in the country's gold mining industry. Investors who purchase shares in South African mining companies must be aware of this uncertainty in order to make proper decisions.
Investing in new mining companies or start ups
The most famous gold mining stocks that you'll usually find in exchange-traded funds nearly always have operating mines.
However, there are many small mining companies that don't have operational mines. Their whole value is dependent on their ability to move projects out of the development phase so that they can begin extracting gold from the mine.
Northern Dynasty Minerals is a good example of how unpredictable pre-production gold mining stocks can be (NYSEMKT: NAK).
The small Canadian company has a stake in the Pebble Project, a region where analysts say there could be some of the world's largest estimated and indicated reserves of gold, silver, copper, and molybdenum.
With some estimates of reserves showing 71 million ounces of gold likely available for mining, interest in the Northern Dynasty's prospects has reached a boiling point in the past.
The issue is that the Pebble Project isn't even near to being ready for production. Northern Dynasty has dealt for years with the permitting process, and the property is close to Bristol Bay, Alaska, which is a critical location for salmon fishing operations. There has been a lot of opposition to establishing a mine in there.
Not only are activists and local residents opposed to Northern Dynasty, but commercial interests in the salmon industry have banded together to try to discourage further growth of the Pebble Project.
As a result, Northern Dynasty generated no income and had to continue to invest money in order to move further.
Not only does the permit work necessitate financial resources, but Northern Dynasty is also performing infrastructure, feasibility, and environmental studies that will offer crucial details later in the approval process.
Exposure to gold streaming stocks
Finally, as we talked about earlier about gold mining ETFs, investors must determine whether they want to invest exclusively in companies with active gold mining operations or include gold streaming companies in their portfolio.
Streaming companies' fortunes are linked to those of mining companies, but the essence of their exposure is very different.
Streaming companies such as Franco-Nevada (TSX: FNV), Royal Gold (NASDAQ: RGLD), and Wheaton Precious Metals (NYSE: WPM) form alliances with mining companies to provide essential resources for mine production and exploration.
A gold streaming company can usually provide a certain sum of money for a gold mining company to use in its business activities.
In return, the mining company will agree to sell a fraction of a mine's production to the streaming company either for a fixed sum or a percentage of the gold produced.
The price paid for the gold by the streaming company is usually a fraction of its market value, essentially repaying the money extended in the first place.
You can see why this business model is dependent on the mine's progress. With a fixed sum of money out of pocket, the streaming company must ensure that the money it earns from the mine will be adequate to repay its expenditure and deliver a fair return.
If the mine is a failure, both the streaming company and the miner will lose money. If the mine does better than anticipated, the streaming company could make a lot of money depending on how the deal is set up.
However, streaming companies' exposure is usually restricted in both directions. On one side, the streaming company would not be held to the same standards as the mining company in the case of a significant problem, such as a mining accident.
However, since the volume of production subject to the streaming contract is usually limited at a certain level, the streaming company may not participate if original projections of a mine's production turn out to be substantially understated.
There is no right or wrong response when it comes to whether gold streaming stocks should be included in a portfolio.
They're simply a slightly different way to gain exposure to the gold market with pros and cons that investors should consider and draw their own conclusions from.
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When does gold mining stock perform well?
A gold mining stock performs the best when increasing gold prices combined with a successfully operating gold mining business.
Stocks of gold mining companies that have multiple operational areas usually move up together with the rise in the gold price. Smaller cap mining company stocks may not behave the same since they have more operational risks. However, smaller-cap mining companies usually have more upside potential.
What are the risks mining companies have?
Exploration risk is essentially the risk that the material pursued by a mining company does not exist. Exploration risk is also known as “assay risk” because assay results determine whether or not a large reserve exists.
While both old and new companies are subject to this form of risk, the exploration risk for older companies is often distributed over a variety of grounds.
Because of its huge portfolio of claims and the capital buffer it uses to fund further discovery, having some experiments come up empty is less financially detrimental to an established mining business.
Each argument has higher marginal importance for new companies, who possess a smaller portfolio of claims.
This is why new mining businesses typically have geologists on their management teams; when they begin investing money on planning and testing a claim, they want to focus on the claims that are most likely to produce, because they haven't much money to blow.
Even if an assay indicates the presence of something, there is no assurance that geological problems, such as a low mining rate, dilution, or other factors will not render the reserve unfeasible in the current market.
While this isn't as bad as doing nothing at all, it does leave the company holding a deposit that won't be used until prices go up.
Making feasibility much more complicated is the fact that certain countries charge a tax on all undeveloped claims or cancel claims after a certain duration of inactivity.
Once again, the effect of this risk differs between larger and smaller companies. Larger companies are usually happy to sit on deposits because they already have profitable mines that allow them to wait for either extraction capabilities to develop or commodity prices to increase, making the deposit more viable.
Depending on the country, a large company would usually consider the holding costs on a claim to be fair. For smaller companies, a difficult mine sometimes means partnering with a major company or selling the claim at a discount to the possible reserves in order to evade losing money by keeping the claim for an unpredictable return in the future.
Any business faces management risk, but mining stocks are especially vulnerable to executive problems. Mining is a long-term business, so the consequences of a weak management team will take years to emerge and much longer to recover.
The most serious harm a management team can do is on the balance sheet. Mining is a capital-intensive industry. If a business does not have ready capital on hand, ramping up operations to meet rising market prices can be difficult.
Majors may turn to the debt market in these cases, but long-term debt has its own set of costs. Since the debt market is difficult to access for juniors, their last choice is typically another share sale, which dilutes shareholders and ultimately scares away other investors.
In certain cases, entering the debt market or selling additional shares may be excellent long-term measures. However, a management team that regularly uses these methods of funding is questionable.
Mining companies operate in a variety of countries, each with its own set of rules about mining claims, foreign property ownership, and so on. Some countries' laws are seldom changed, whereas others have more volatile legal structures.
So, even though a mining company has a great reserve, the resources to grow it, and a favorable market, a shift in the political climate where the deposit is located will curtail the process of bringing the minerals to market.
Companies based in developed countries are preferable in terms of risk, but mining companies go wherever the minerals are, so it is also a matter of how much political risk an investor finds appropriate.
Gold mining stocks may be a good diversifier for stock portfolios because they expose investors to an asset that is well known and has the ability to retain its value while also providing some protection against structural threats. One drawback is the potential lack of dividends, which can hurt investors who are looking to supplement their income streams.