Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Why Nvidia Is My “Slam Dunk” Stock Investment for the Decade - 16th Jan 21
Three Financial Markets Price Drivers in a Globalized World - 16th Jan 21
Sheffield Turns Coronavirus Tide, Covid-19 Infections Half Rest of England, implies Fast Pandemic Recovery - 16th Jan 21
Covid and Democrat Blue Wave Beats Gold - 15th Jan 21
On Regime Change, Reputations, the Markets, and Gold and Silver - 15th Jan 21
US Coronavirus Pandemic Final Catastrophe 2021 - 15th Jan 21
The World’s Next Great Onshore Oil Discovery Could Be Here - 15th Jan 21
UK Coronavirus Final Pandemic Catastrophe 2021 - 14th Jan 21
Here's Why Blind Contrarianism Investing Failed in 2020 - 14th Jan 21
US Yield Curve Relentlessly Steepens, Whilst Gold Price Builds a Handle - 14th Jan 21
NEW UK MOT Extensions or has my Car Plate Been Cloned? - 14th Jan 21
How to Save Money While Decorating Your First House - 14th Jan 21
Car Number Plate Cloned Detective Work - PY16 JXV - 14th Jan 21
Big Oil Missed This, Now It Could Be Worth Billions - 14th Jan 21
Are you a Forex trader who needs a bank account? We have the solution! - 14th Jan 21
Finetero Review – Accurate and Efficient Stock Trading Services? - 14th Jan 21
Gold Price Big Picture Trend Forecast 2021 - 13th Jan 21
Are Covid Lockdowns Bullish or Bearish for Stocks? FTSE 100 in Focus - 13th Jan 21
CONgress "Insurrection" Is Just the Latest False Flag Event from the Globalists - 13th Jan 21
Reflation Trade Heating Up - 13th Jan 21
The Most Important Oil Find Of The Next Decade Could Be Here - 13th Jan 21
Work From Home £10,000 Office Tour – Workspace + Desk Setup 2021 Top Tips - 12th Jan 21
Collect a Bitcoin Dividend Without Owning the King of Cryptos - 12th Jan 21
The BAN Hotlist trade setups show incredible success at the start of 2021, learn how you can too! - 12th Jan 21
Stocks, Bitcoin, Gold – How Much Are They Worth? - 12th Jan 21
SPX Short-term Top Imminent - 12th Jan 21
Is This The Most Exciting Oil Play Of 2021? - 12th Jan 21
Why 2021 Will Be the Year Self-Driving Cars Go Mainstream - 11th Jan 21
Gold Began 2021 With a Bang, Only to Plunge - 11th Jan 21
How to Test Your GPU Temperatures - Running Too Hot - GTX 1650 - Overclockers UK - 11th Jan 21
Life Lesson - The Early Bird Catches the Worm - 11th Jan 21
Precious Metals rally early in 2021 - 11th Jan 21
The Most Exciting Oil Stock For 2021 - 11th Jan 21
Financial Market Forecasts 2021: Navigation in Uncharted Waters - 10th Jan 21
An Urgent Message to All Conservatives, Right-Wingers and Patriots - 10th Jan 21
Despite Signs to the Contrary, Gold Price at or Near Top - 10th Jan 21 -
Ultimate Guide On The 6 Basic Types Of Index Funds - 10th Jan 21
Getting Vaccinated at TESCO - Covid-19 Vaccinations at UK Supermarket Pharmacies and Chemists - 10th Jan 21
Cheers for the 2021 Stock Market and These "Great Expectations" - 9th Jan 21
How to Plan Your Child With Better Education - 9th Jan 21
How To Find The Best Casino - 9th Jan 21
Gold Is Still a Bargain Buy - 8th Jan 20
Gold Price Set to Soar as Hyperinflation Looms - 8th Jan 21
Have Big Dreams? Here's How to Pay for Them - 8th Jan 21
Will the Fed Support Gold Prices in 2021? - 8th Jan 21
Stocks trading strategies for beginners - 8th Jan 21
Who is Buying and Selling Stocks in 2021 - 8th Jan 21
Clap for NHS Heroes 2021 as Incompetent Government Loses Control of Virus Again! - 8th Jan 21
Ultimate Gaming and Home Working PC System Build 2021 - 5950X, RTX 3080, Asus MB - Scan Computers UK - 7th Jan 21
Inflation the bug-bear looking forward through 2021 - 7th Jan 21
ESG ETF Investing Flows Drive Clean Energy to Fresh Highs - 7th Jan 21
5 Financial Market Surprises in 2021 - 7th Jan 21
Time to ‘Reset’ Your Investment Portfolio in 2021? - 7th Jan 21
Bitcoin Price Collapses almost 20% at the start 2021 - 7th Jan 21
Fed Taper Nervous Breakdown - 6th Jan 21
What Will the U.S. Dollar Ring in for 2021? - 6th Jan 21
Stock market frenzy- Ride the bandwagon but be sure to take along some gold coins - 6th Jan 21
Overclockers UK Custom Build Gaming System Review Heat Test and Final Conclusion - 6th Jan 21
Precious Metals Resuming Bull Market, Gold, Silver, GDX Trend Forecasts 2021 - 5th Jan 21
Trump’s Iran-COVID-Gate Anniversary  - 5th Jan 21
2021 May Be A Good Year For The Cannabis / Marijuana Sector - 5th Jan 21
Stock Market Approaching an Important Target - 5th Jan 21
Consumer Prices Are Not Reflecting Higher Inflation; Neither Is The CRB - 5th Jan 21
NEW UK Coronavirus PANIC FULL Lockdown Imminent, All Schools to Close! GCSE Exams Cancelled! - 4th Jan 21
The Year the World Fell Down the Rabbit Hole - 4th Jan 21
A Year Like No Other for Precious Metals… and Everything Else - 4th Jan 21
The Stocks Bull Market is Only Half Completed - 4th Jan 21
An In- Depth Look At Gold Price Trend - 4th Jan 21
Building America Back After a Dark Covid Winter - 4th Jan 21
America's Dark Covid Winter Ahead - 4th Jan 21
Buy a Landrover Discovery Sport in 2021? 3 Year Driving Review - 3rd Jan 21
Stock Market Major Peak in Early April 2021 - 3rd Jan 21
Travel and Holidays 2021 - Flight Knight Cabin Bag Review - 3rd Jan 21
�� Happy New Year 2021 Fireworks and Drone Light Show from London and Sheffied - BBC�� - 2nd Jan 2
The Next IMMINENT Global Catastrophe After Coronavirus - 1st Jan 21

Market Oracle FREE Newsletter

FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

Are Gold Stocks The Real Barbarous Relic?

Commodities / Gold & Silver Stocks Jul 12, 2011 - 01:52 AM GMT

By: Bob_Kirtley


Best Financial Markets Analysis ArticleIn 1924 John Maynard Keynes referred to the gold standard as a “barbarous relic”, but we think the new barbarous relic is using gold stocks as a trading or investment vehicle in an attempt to benefit from rising gold prices. This isn’t the 1970s. One can buy GLD call options from a laptop in bed or take a long position in gold futures with a few taps on a smart phone whilst in line at a coffee shop. The days of having to call a broker and hopefully buy some gold shares that will hopefully go up if the gold price goes up are over. There is no longer any need to take the risk that your gold stocks will not go up with gold.

First off let us say that the aim of this article is not to discredit any gold mining or exploration company, or the efforts of the industry. We are not saying there isn’t money to be made in the gold mining industry, we are simply saying that gold stocks are unsuitable for trading gold and unsuitable for investing in rising gold prices. Many companies may be worth a buy on their own merits, but we do not think they should be bought to gain exposure to rising gold prices. There may be many undervalued gold companies out there, but then the reason for buying them is more on a valuation basis and not as a ploy to profit from rising gold prices. A gold stock may be a good investment, but using it as a vehicle to benefit from rising gold prices is a poor trading strategy. We are not saying that there isn’t money to be made from investing and trading gold stocks, but that is a separate issue from using gold stocks to play upwards moves in gold prices.

Why do many people continue to think gold mining/exploration stocks are a good investment to play rising gold prices? Even investors with stellar reputations such as John Paulson have large holdings in gold equities as a way to play rising gold prices, which is puzzling to us. One may be able to defend holding gold stocks if one is managing a mutual fund where by the mandate may prevent you from investing in physical gold or trading derivatives, but with ETFs even this is a very weak argument. This makes Paulson’s choice all the more bewildering since he runs a hedge fund and so can trade futures, options or whatever he likes (and in fact he came to fame by trading credit default swaps).

Investing in gold exploration stocks built purely on the premise that gold prices are going higher is a poor reason to place a trade. The price of the exploration stocks depends far more on whether or not they have the gold, much more than the gold price. If a junior exploration stocks successfully finds a great gold deposit then their stock price will rise, whether the gold price is $1000, $1500 or $2000. In addition to this it might be 10 years before they actually get the gold out the ground to sell it and who knows what the gold price will be then. It may be the case that the gold bull market has come and gone long before the explorer gets to sell just one ounce of gold.

Picking undervalued stocks is a separate process and area of expertise from that of trading commodities such as gold. If one thinks one can pick gold exploration plays that are going to do well, then one can apply the same reasoning to silver, copper and other metal explorers. If one is good at this it doesn’t matter so much if the underlying metal price is going to rise in the next year, as if a company makes a great find it will usually do well regardless.

An argument often cited by those investing or trading gold stocks is that they could outperform the gold price. The argument goes something like if it costs the company $500/ounce to mine gold and the gold price rises from $1000 to $1500 then the company is making twice as much, whereas the gold price has only increased 50%. It sounds fairly logical. However in reality the costs of mining are most often rising too.

What most is important about this is that many of the costs of mining gold are actually often positively related with the gold price. For example oil prices and gold prices are somewhat positively related so if the gold price is going higher in coming years, chances are that oil prices may well be higher too, leading to increased fuel costs involved with gold production. Plus if you are holding gold investments as an inflation hedge, then holding gold stocks isn’t as good a deal as it first may appear as the gold miner’s costs base will be inflating too.

On top of this gold is getting harder to find and more expensive to extract when it is found. This is one of the reasons why the gold price has been increasing, the supply side is constricted, and yet it is often cited by people who then go on to recommend investing in the mining industry.

It is somewhat ironic that one would believe gold prices would rise in part due to mining becoming increasingly difficult and more expensive, but then invest in companies that will suffer from those very factors. The same applies to explorers. If one believes that gold is getting harder to find and that will contribute to higher gold prices, why would one invest in companies that are trying to find gold? Why not just in gold itself?

Our biggest problem with owning gold stocks is this: Where is the compensation for the extra risks?

The follow list identifies just some of the risks involved in mining and exploration that we do not think are being adequately compensated for.

Where is the compensation for Geo-political risk?

Examples: Nationalization of mines, disruption of mining due to conflict

Where is the compensation for managerial risk?

Examples: Management may make poor decisions that have an adverse impact on the stock price, say by acquiring another company at an unfavorable price.

Where is the compensation for labor risk?

Examples: Labor costs may increase, work force may go on strike.

Where is the compensation for technical risk?

Examples: Difficulties mining, problems with the deposit, downwards revision of resources estimates

Where is the compensation for environmental risk?

Examples: Adverse weather or natural disasters affecting the project(s)

Where is the compensation for tax risk?

Examples: Changes in the tax structure of the country the project is in which reduce its profitability, such as higher taxes or mining specific royalties being imposed.

These risks are not properly compensated for by the performance of mining stocks. Therefore one should not take these risks and should not use gold stocks in an attempt to profit from rising gold prices.

In order for gold stocks to be worthy of an investment, they must outperform the gold price to compensate for the extra risks the investor is taking on. Out-performance is very different from leverage. Gold stocks must increase more when gold prices increase and decrease by less when gold prices decrease. At present even if the gold stocks manage to squeak out larger gains than gold when gold prices increase, they fall far further than gold when prices decrease. This isn’t out-performance, this is simply leverage and in this modern financial world leverage is cheap and easy. One doesn’t need to take the additional risks that gold stocks bring to get leverage to the gold price; one can buy an ETF using margin, buy a leveraged ETN or even a leveraged ETN on margin that will track the gold price almost exactly with a large degree of leverage. Not to mention one could use futures and options to add leverage too.

Of course there are some star performers in the junior sector and talented, experienced veterans of the industry may be able to pick some great winners. However overall as a sector it has severely underperformed in our opinion, especially on a risk adjusted basis. Having a few juniors that rise tenfold isn’t good enough for us, since if one is investing in gold explorers, you should own more than a few in order to diversify your risk. Also if you hold less exploration stocks, you have less chance of holding the one that hits the mother lode. One cannot have it both ways.

This bull market started in 2001, so perhaps there were periods of out-performance by gold stocks. Actually gold stocks stopped outperforming around 2002-2003. The only other period that one would have enjoyed some outperforming is measuring from the 2008 financial crisis low to date, but virtually every stock has done well measuring its performance from then.

We cannot understand why many people will still insist on gold stocks as a viable vehicle for gaining exposure to rising gold prices. Maybe the reasoning was sound 30 years ago, but it isn’t now. A possible reason is that gold stocks are interesting to talk and write about. Well something being interesting doesn’t interest us; we are interested in maximizing our profits – even if we do not produce reams of research on a myriad of junior explorers for our subscribers. We use options to trade gold, options on GLD which are easily available and viable for the majority of investors. Our model portfolio has grown at an annualized rate of 117% and we have only used options on gold stocks twice, both of which were bearish and profitable trades. Through using options we can create the leverage we require and through our own efforts at timing the market we believe we offer out-performance as well, since options can allow one to profit if the price goes up, down or even sideways..

In conclusion we do not think gold stocks are a suitable vehicle for trading gold and we also do not think gold stocks make a suitable investment for those wishing to profit from higher gold prices. Gold stocks do not offer adequate compensation for the extra risks involved. They do not outperform. They barely offer leverage and even if they do, that is not enough. Of course there will be exceptions and opportunities for savvy investors to make money in this industry. However as a whole the entire premise of investing in gold stocks as a way to gain exposure to rising gold prices is flawed, outdated and quite frankly a “barbarous relic”.

To stay updated on our market commentary, which gold stocks we are buying and why, please subscribe to The Gold Prices Newsletter, completely FREE of charge. Simply click here and enter your email address. (Winners of the GoldDrivers Stock Picking Competition 2007)

For those readers who are also interested in the silver bull market that is currently unfolding, you may want to subscribe to our Free Silver Prices Newsletter.

DISCLAIMER : Gold Prices makes no guarantee or warranty on the accuracy or completeness of the data provided on this site. Nothing contained herein is intended or shall be deemed to be investment advice, implied or otherwise. This website represents our views and nothing more than that. Always consult your registered advisor to assist you with your investments. We accept no liability for any loss arising from the use of the data contained on this website. We may or may not hold a position in these securities at any given time and reserve the right to buy and sell as we think fit.
Bob Kirtley Archive

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules