Investing in gold stocks adds diversification to a portfolio. Historically, gold has had a negative correlation to equities. It’s also viewed as a hedge against inflation and a flight to safety investment.
Why should you buy gold stocks instead of owning the physical metal?
Gold bugs will argue that if you don’t have gold your hand you don’t own it. However, there are several downsides to owning gold.
First, its expensive. Spot gold closed above $1,300 an ounce in 2017. When you buy physical gold, there is an additional premium added to the spot price. A 1 ounce American Gold Bullion Coin goes for $50-$70 above the spot price. In smaller gold bullion increments the premium is even higher. This makes investing in gold bullion extremely challenging for those who don’t have a lot of funds.
Second, there are security and storage fees that you must deal with. These expenses cut into your potential profits from the rise of gold.
Third, when its time to sell your gold bullion, dealers typically will pay you near the spot price. So you pay a premium to get in and lose that premium on the way out.
Lastly, you don’t gain any interest from holding gold. However, many of the top gold stocks offer their investors dividends.
Buying gold stocks can actually be more profitable than investing in the physical metal.
How so?
Well, a gold miner knows their costs for a given project. For example, if it costs them $900 to produce a gold of ounce, and gold prices rise, they are essentially generating more profits without increasing costs.
That said, investing in a gold stock gives you optionality. Not only you can profit from the potential rise of gold, but if you invest in a gold company that keeps operating costs low and is productive, your gains can substantially outperform that gold bullion.
Four Different Ways To Invest In Gold Through The Stock Market
Senior Mining Gold Companies
These are well established gold producing companies. They tend to have a market cap that exceeds $3B, a diversified portfolio of assets, offer investors a dividend, have a steady cash flow with low operating costs.
They are involved in mining, producing, and developing gold mineral deposits.
Kinross Gold Corporation (NYSE: KGC): A senior gold mining company with a diverse portfolio of mines and projects in the United States, Brazil, Chile, Ghana, Mauritania, and Russia.
As of December 31, 2016, it had proven and probable mineral reserves included 31M ounces of gold. Through the third quarter of 2017, its all-sustaining cost of gold was $933 per ounce.
The stock price is owned primarily by institutions, as approximately 70% of the stock ownership comes from institutions.
The firm’s market cap puts them in the top ten among gold mining companies.
Newmont Mining Corporation (NYSE: NEM): Recognized as being the only gold company listed on the S&P 500. In 2016, the firm generated net cash from continuing operations of $1.9B and more than doubled free cash flow to $784M.
As of December 31, 2016, it had proven and probable gold reserves of 68.5M ounces. In that same year, Newmont returned $67M in dividends to shareholders.
Newmont’s assets are located in the United States, Australia, Peru, Indonesia, Ghana, and Suriname.
The firm has the highest market cap out of any gold miner, exceeding $20B. It dishes out a $0.30 annual dividend to its investors.
Gold Junior Miners
These firms are not as well established and are not drawing large revenues from the production of gold. They are primarily exploring, in search of new deposits of gold.
Much of its valuation is derived from the assessment of its properties and its financial condition. Without substantial revenue, its important that these companies don’t over dilute and get in debt problems.
Novo Resources Corp (OTC: NSRPF): Its focus is on exploring and developing gold projects in the Pilbara region of Western Australia. It has built up a significant land package covering approximately 12,000 sq km.
Its present focus is its Beatons Creek and Marble Bar paleoplacer gold projects.
Since its inception, the company stock has outperformed the S&P 500 and gold bullion.
Source: Morningstar
Streaming And Royalty Companies
These companies act more like a bank, injecting capital to mining companies so they can explore and produce gold.
They receive royalties on what the mining company produces. There are two main types of royalties: revenue-based royalties and profit-based interest royalties.
A revenue-based royalty is derived from the value of gold production from a given project. A profit-based interest royalty is derived from the operating profit as defined by its contract.
Streams are metal purchase agreements that provide, in exchange for an upfront deposit, the right to purchase all or a portion of gold produced from a mine at a predetermined time.
Royal Gold, Inc. (NYSE: RGLD): The firm is engaged in the acquisition, and management of precious metals streams and royalties. With a focus on gold, its portfolio includes 39 producing and 23 development-stage royalties or small interests.
The company has low fixed costs, a diversified portfolio, and offers its investors a $1 annual dividend per share. Since its inception, Royal Gold has outperformed both the S&P 500 and the price of gold.
Diversification Through ETFs
You can also gain exposure to gold via exchange traded funds. There are ETFs that try to track the performance of gold. Such ETFs include SPDR Gold Shares (NYSE: GLD) and iShares Gold Trust (NYSE: IAU).
For those looking for more action, look at ETFs that invest in a basket of gold miners and streaming and royalty companies.
For example, the VanEck Vectors Gold Miners ETF (NYSE: GDX) has holdings in:
Source: Morningstar
For those with a higher appetite risk might consider the VanEck Vectors Junior Gold Miners ETF (NYSE: GDXJ). Some of its largest holdings include:
Final Thoughts
Buying the best gold stocks could lead to greater gains when compared to owning gold bullion or coins. However, your not only buying something that reacts to the price movements of gold, but you are also investing in the management of the company.
Take the time to read about the management and the projects set out by the firm. Is their growth organic or are they relying on diluting shares or borrowing money?
Are their all-in costs low, or is their performance highly sensitive to the price swings of gold.
Before you buy any gold stock make sure to do your own due diligence.
