In times of economic struggle and social upheaval, investors often become more interested in precious metals, especially gold. Long-term, growth-oriented investors often don’t pay much attention to gold-related investments since it can be hard to understand the cyclical nature of the industry and how it relates to global economies.
With a level of turmoil that never seems to end both here in the U.S. and abroad, perhaps it’s a good time for investors to consider adding some exposure to gold. Here are a few reasons why.
For investors who focus on stocks, gold-related investments can provide a significant hedge against stock market downturns. When the stock market slides into troubled territory, gold and gold mining stocks tend to see their values increase.
Gold tends to hold its value over time, especially during periods of geopolitical uncertainty, and can serve as a hedge against both inflation and declines in the U.S. dollar. The world’s limited supply of gold and growing demand for the metal supports increasing prices over time.
There are three ways that individuals can invest in gold:
- Purchase gold ingots, bars, or coins. But this gold must then be safeguarded, which introduces storage costs, and additional federal tax forms are required when selling and tax rates are higher than for common stocks.
- Purchase (ETFs) that either hold gold directly or own shares in publicly-traded gold mining businesses. While ETFs trade on stock exchanges and are gold) are taxed as if the investor held the underlying commodity directly (not at the capital gains tax rate for common stock). ETFs that own gold mining companies are often a good way to gain exposure and diversification without having to worry about individual company selection. In addition, gold ETFs may be optionable, allowing for calls and puts to be bought and sold.
- Purchase shares of gold mining or royalty company stocks directly. Gold miners are companies that own and operate mines directly, while royalty or streaming companies provide cash to a selection miners in return for a percentage of the output of each or the right to purchase the mined metal at below-market prices. In effect, royalty companies serve as small managed mutual funds that do their own research and seek out the best opportunities before they invest.
According to our usual practice, we believe that it is possible to select individual companies that outperform the indexes, so we have dug into companies in the gold mining industry, both miners and royalty companies, before settling on our recommendation in this issue for the stock that appeared to offer the best combination of value and return at its current price.
Our selection turned out to be a gold miner and not a royalty/streaming company, though several royalty companies were on our short-list. Some investors might find owning a royalty company to be a “safer” approach to investing in gold mining stocks since it provides instant diversification.
In analyzing gold mining stocks, it’s important to understand that, at the end of the day, they’re no different than any other business. They make money if the cost of producing their product is less than the price for which they can sell it. If their “all-in sustaining costs” (AISC) are higher than the price of gold, then the risk of insolvency can be very high.
Gold miners may try to scale their output to match market prices, which is quite difficult if not impossible—witness the large number of publicly-traded gold miners that are currently unprofitable. It’s no use hitting a new vein and having a banner production year if gold prices have fallen. As a result, many gold miners hedge their exposure to gold price risk using derivatives.
While our selected stock can be analyzed using the Stock Selection Guide, the characteristics of other miners and royalty companies often don’t fit the analytical framework as well. EPS and revenues can be less consistent, and P/E ratios can seem excessively high by usual standards.
When considered against the longer-term cycles of gold prices, though, these companies could still be considered reasonable investments at their current prices. When studying some profitable gold mining companies, you might put less weight on the importance shorter-term growth trends and historical growth consistency, and consider current P/E ratios in the context of the company’s history, not relative to peers or the broader market of growth stocks.
Gold miners with the ability to make a profit fairly consistently are rare to come by, so be sure to evaluate them appropriately.
In the October 2020 issue of the SmallCap Informer newsletter, we introduce two new companies to our coverage. Both have a defensive bent but also have drivers for good near- to mid-term performance, reflecting our tactical pivot towards companies that could be standouts no matter where the market is headed.
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