Traits of the Best Gold Mining Stocks

Keep These Points in Mind When Trading Precious Metals Stocks

Gold nugget 'trapped' in quartz. Gold mining industry, Val d'Or, Quebec, Canada
Pierre Longnus / Getty Images

The price of most precious metals, including silver and gold, could be much higher several months from now. All sorts of various and meaningful events are conspiring to potentially set precious metals prices up to move higher from their current levels, including but not limited to:

Excessive Worldwide Money Printing

Technically there is no actual "printing" involved in most cases, as much as there is a lot of bond and debt buying, and digital adjustments to government balance sheets.

However, it still has the same effect — more dollars (or digital dollar-equivalents) decreases the value of each, and when something (gold, oil, coffee, steel...) is purchased with a weaker currency, it takes more of those dollars to buy it. This will manifest, or appear, as rising commodity prices.

Increasing Demand From Nations Such as China and India

Add Russia, Mexico, and many others to this list, and the demand picture becomes clear. There have never been so many worldwide Central Banks, as well as jewelry-buying populations, as we are seeing in recent years.

Ongoing Loss of Purchasing Power for the Dollar

Since 1900, the U.S. dollar has lost 97 percent of its purchasing power. This trend will continue, and almost certainly will even accelerate, in response to the multi-trillion dollar money supply spike over the last (very) few years. In fact, the total American currency in circulation has quintupled in the last few years.

So yes, I anticipate that gold and all precious metals will perform very well in the coming years. As a resulting extension to that belief, the mining companies that are extracting the resources in question (gold, platinum, silver, palladium...) would also benefit.

However, this does not mean that every publicly traded commodity-mining company will rise.

They certainly will not all increase by an equivalent amount either.  

Assuming the yellow metal acts as we anticipate, the potential winners can be identified ahead of time, by keeping the following points in mind:

Production vs. Exploration: You may see more significant gains from the companies involved with extracting and producing the metals than companies simply "exploring" for them.  A developed and operating mine is many times better than any company still looking to eventually... hopefully... years from now... reach the actual working phase.

Outsized Gains: If gold and silver prices went up 10 percent, the corporations which are actively mining, extracting, and selling the commodities may see benefits of much more than that amount. In some cases, a tiny rise in the price of precious metals will translate into a major leap in their profits.

This is because the production costs are set. If a mine spends $1,000 to dig up and sell gold for $1,100, they make a 10 percent profit ($100). If gold prices move to $1,300 per ounce, their production costs are still $1,000, and now the profits become $300 — an 18 percent increase in gold prices can equal a 200 percent spike in their earnings!

Companies Are Run by People, Commodities Are Not: Trading the mining companies is an attractive strategy for investors looking to benefit from any rise in precious metals prices. However, gold itself cannot be sued, or lose big customers, or be affected by an ineffective management team, or lose millions of dollars due to an ill-advised acquisition — BUT a company can.

In this sense, operating mines are much more vulnerable to company-specific threats and risks. Physical metals (just like any true commodity) are immune to those kinds of concerns.

Is Paper Gold Worth the Paper It Is Printed On?

Many investors will buy GLD, which is the exchange-traded fund that mimics the price of the metal. Then they will say, "there, now I own some gold." The unfortunate reality is that they hold a piece of paper which theoretically gives them claim to a basket of companies...

but it is nothing more than a derivative, or may be even worse — simply a loosely-enforceable "arrangement."  

A derivative "derives" it's value from other assets, without actually laying claim to any of them. You get no share certificates of the companies involved, and you also receive no gold. With most paper gold investment vehicles, each single ounce of actual gold has claims laid upon it by as many as 70 different people. The only reason this "works" is that no one is actually requesting delivery of the contractually indicated commodity... yet.

Cruising Altitude and Heavy Lifting

There are all sorts of hurdles for any mining company in the early stages:

  • attaining the necessary permits
  • environmental assessment reports
  • community impact reports
  • arrangements and/or deals with the endemic populations and First Nations' groups
  • acquiring the workers for their mines, and staff for their offices
  • bringing all the necessary machinery to bear
  • financing the operating activities
  • geological surveys

However, once a mine is up and running in the production phase, they have already dealt with all of these early-stage issues. Why invest in a "potential, one-day promise," when you can own shares in a company which is already running now? For the investor looking for exposure to precious metals, it usually makes more sense to purchase shares in a company which is already in the production phase, than it does to buy stock in an exploration play.

Paying Tuesday for a Hamburger Today

Once a company is operating to extract a resource from their mine, and even before that point in many cases, they may pre-sell or forward hedge much of their production. This means that they will receive a cash influx from an investor group now, in exchange for the promise to pay for that loan or bond with the resource they will eventually extract.

In other words, they agree to a locked-in price. So even if gold quintupled in value, they still contractually would have to sell for the much lower amount based on the legal agreement. The effect of this forward-hedging means that the operating mine would get no benefit from increases in the value of the commodity.

All of these events could lead to a significant increase in gold prices by November or December. But keep in mind that to position yourself into gold at that point near the end of the year may be too late. The biggest winners, in my opinion, will be those who act before the asset gets onto everyone's radar, not the ones who jump on board in the more volatile days. Of course, aren't those true words for every type of investment?

2017 could be "the year" of precious metals, as well as gold mining companies. Investors will not get rich holding commodities like gold, but they will preserve the wealth they have, while just about everything else could be at risk of falling if we see a recession or stock market "reset."