A friend recently suggested investing in gold mining stocks due to their slower growth than gold. When these lines were written, gold had increased more than the Philadelphia Gold &Silver Index (XAU) for three years, rising 66% and 58%, respectively (including dividends). Additionally, technical stock market observers of the XAU have pointed out that it is time to purchase stocks when gold consistently outperforms index components. Since stocks are, in some ways, a call option on gold, they frequently rise before the precious metal during a gold bull market. This indicates that gold stocks, particularly those with abundant reserves ready to be exploited, will appreciate more quickly when gold begins to rise. However, this has not taken place in recent years.
Why? Due to rising labor costs, higher prices, increased energy shortages, rising taxes and royalties, and the sheer difficulty of digging deeper to extract the scarce precious metal, the majority of mining companies are struggling to increase production, and costs are rapidly rising. Ore grades have continued to fall at some important mining operations around the world.1 In May 2007, the mining conglomerate Newmont reported disappointing earnings as a result of rising energy and other costs. In just one year, costs at one of its Nevada mines increased from $395 per ounce to nearly $500.2 Earnings in the gold mining industry—the primary factor in stock prices—have been disappointing due to rising costs. Therefore, mining stocks carry many of the same uncertainties as other stocks, such as rising costs, despite being exposed to rising gold price. The fact that many mining operations are located in faraway nations where volatile governments have the ability to alter the rules presents additional risk. Nationalize or outright confiscate mining operations, raise taxes, or interfere with operations. Leaders may be justified in attempting to confiscate some of their profits in the event that their profits significantly rise during a silver gold bull market—which could occur in conjunction with a weak economy. It has undoubtedly occurred before.
Despite these concerns, a gold investor can frequently gain more by investing in mining stocks than by purchasing gold on its own; in fact, this occurs frequently. The smaller mining plays, in particular, can double, triple, and more on news of a new gold deposit discovery or their acquisition by a larger company. Buying individual stocks can be exciting and extremely rewarding. However, if you decide to invest in small-cap speculative mining stocks rather than conservatively run mining companies like Barrick, AngloGold, and Newmont, let me tell you about Bre-X. Mark Twain's cynical observation that "A gold mine is a hole in the ground with a liar on top" demonstrates that the history of gold mining is replete with tales of deception.3 The story of Bre-X, a corporate scandal that rocked the gold mining industry in the 1990s, would have made Twain chuckle.4 Allow me to summarize the key points of this cautionary tale for the sake of conciseness. Bre-X started out as a shady Calgary gold exploration company with no profits or revenues. After failing to locate any gold in the far-flung jungles of Kalimantan, Indonesia, its executives decided to claim that they had discovered rich deposits. Bre - X eventually went from estimating deposits of 3 million ounces of gold to 200 million ounces, which amounted to 70 billion dollars for an asset the company didn't even have a clear title to, by providing false earth samples that gullible investment analysts trusted. Wall Street savored this, salivating over the numerous lies that Bre-X management fed it, and numerous analysts relentlessly promoted the stock, some claiming to have "seen the gold" for themselves. Bre - X went from trading at pennies per share to a peak of $ 286.50 in 1996, when it reached a staggering market capitalization of $ 6 billion, during what we might refer to as its Microsoft phase. During its Enron phase, when a Bre- X executive was on his way to explain why there was no gold dove to his death from a helicopter, the stock ended up trading at seven cents a share.
Although scandals like the Bre - X one are obviously uncommon, investors' ever-present need for quick profits can be exploited by con artists using gold. It is best to invest in some of the gold "seniors" mentioned above, which are large, well-managed companies that typically have solid balance sheets and relatively stable earnings—at least in terms of mining companies—unless you intend to immerse yourself in the mining stock market. There are a number of gold stock indices that have given rise to exchange-traded funds of mining companies for the investor who does not have the time to spend hours looking for the ideal stock or group of stocks. The majority of major investment firms also have gold or precious metals funds that make investments in a group of mining companies located all over the world.
