For those who are bullish on the price of gold, investing in gold stocks is a very interesting option. We analyze the 4 types of gold miners, so you know the basics of investing in this sector.
- Introduction to Investing in Gold Stocks
- Types of Gold Miners
Introduction to Investing in Gold Stocks
Gold is the true safe haven asset. Investing in gold increases the stability and diversification of our investment portfolio, and protects us against scenarios of elevated inflation, stagflation and monetary chaos.
However, there is another way to benefit from a rising price of gold: investing in gold stocks, i.e. shares of gold-producing companies. If the price of gold goes up, the profits of these companies can increase dramatically.
If you would like to invest in gold mining companies, you should be aware that it is a much riskier investment than the precious metal itself.
Despite the fact that the price of gold is quite volatile, gold is a very easy investment to manage and understand. If we buy gold at $1,800 per ounce and the price goes up 15% to $2,070, our profit will be 15%. If the price drops by 15% to $1,530, our loss will be 15%.
However, the calculations are a lot more extreme for gold miners. This is because their expenses are mostly fixed. Let us use a hypothetical example to understand why gold stocks are much more volatile than gold itself:
A gold mining company has a production cost of $1,200 per ounce. At $1,800, its profit is $600 per ounce. If the price goes up to $2,070, the profit per ounce increases to $870, or 45%. But if the price drops to $1,530, the profit drops to as little as $330, a 45% drop. Because of that, it is said that investing in gold miners is a leveraged bet on the price of gold. At the end of the day, for our hypothetical company, if the price of the metal falls below $1,200 per ounce, all profits would evaporate. But if the price goes up to $3,000, its profits will triple.
Types of Gold Miners
We will analyze the 4 types of gold mining companies, from the most stable to the most speculative:
The “Majors” are the largest gold mining companies. They are generally those whose annual production is greater than one million ounces per year. Consequently, gold majors operate several mines around the world.
Its high production output, reserves, geographical diversification, and strong balance sheet makes these types of companies the strongest and most stable in the sector. Normally, they are also the ones with the lowest production costs, making them able to withstand falls in the price of gold.
For all these reasons, if this is the first time we invest in gold mining stocks and we do not want to take too much risk, gold majors are a very good option.
If the price of gold rises dramatically in the future, the Majors will go up too, but they will be, in general, the type of companies that will go up the least. This is because their profits are already strong and, therefore, have less room to grow.
Gold majors often acquire smaller gold producing companies with the aim of maintaining or increasing their level of gold reserves underground, making sure that they will be able to continue to operate for many decades.
One of the most famous gold majors is the Canadian Barrick Gold, which is also a member of the stock index S&P 500.
The index that best represents this type of gold mining companies is the NYSE Arca Gold Miners Index. There are ETFs that track it, such as the VanEck Vectors Gold Miners. If you click on the name of the ETF, you will see its main holdings and geographical distribution.
One step below in terms of gold production and size, we have the “Mid-Tiers”. Gold Mid-Tiers have an annual production of between 200,000 and one million ounces of gold. Because of that they also operate fewer mines and have fewer reserves.
The objective of a Mid-Tier is usually to acquire other miners of similar or smaller size to become one of the Majors.
Investing in Mid-Tier mining companies has more risk than investing in Majors. But if the price of gold rises, these stocks are likely to go up more than the Majors.
In the next section we analyze the “Juniors” and discuss how we can passively invest in an ETF composed of Mid-Tiers and Junior miners.
The smallest gold producing companies are the Juniors. Its annual production level is below 200,000 ounces of gold.
Often, their goal is to be acquired by larger companies and generate outsize profits for their shareholders. This usually happens during gold bull markets, when the price of gold rises significantly and investors’ appetite for these types of companies increases.
Juniors are usually the weakest gold producing companies from a balance sheet perspective. As a result, they are the ones that can suffer the most in a bear market. But remember that they are also the ones that can benefit the most if the price of gold increases.
The VanEck Vectors Junior Gold Miners ETF allows us to passively invest in gold Mid-Tiers and Juniors.
Gold Exploration Companies
Finally, we can also invest in gold exploration companies. As the name suggests, these companies are dedicated to exploring for new gold deposits. To finance their activities, they often issue shares to investors.
If the exploration activities are successful, those investors will make a lot of money. Otherwise, the losses are limited to the amount spend on buying those shares. And losses can indeed by 100% in these types of companies.
The goal of these companies is usually not to extract any gold. Once new gold reserves have been found, the project is sold to a larger company that has the ability to develop a mine and build all the necessary infrastructure.
As you can imagine, gold exploration companies are the most speculative. As the price of the metal rises, so does the number of investors willing to finance such activities. After all, the higher the price of gold, the greater the potential profits if gold is found.
As you can see, there are many ways to benefit from a rising price of gold. The current macroeconomic situation is very favorable for precious metals. Therefore, it is likely that we will see higher gold prices in the years to come.
What is always important for investors is to understand the role that each of their investments plays in their portfolio.
While investing in gold, whether physically or through an ETF, can protect our wealth against economic and monetary crises, investing in shares of gold mining companies serves a very different purpose.
Gold miners are a leveraged bet on the price of gold. Its price is highly correlated with the price of the metal, but much more volatile. These companies can generate high profits for us if the price of the gold increases. But they all have different risk/reward ratios.
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