Opinion
Six tips for buying shares in gold companies
Here’s what investors need to think about when considering buying shares in a gold miner.
Elio D'AmatoContributorGold has been a store of value that has lasted an age. Prized for its beauty and non-corrosive elements, gold is an investment that, despite price volatility, is often viewed as a defensive investment.
In the current environment where there are fears of macroeconomic implosions, geopolitical melt-downs and asset bubbles, many investors recently have sought the safety of gold.
Gold explorers that are not yet producing or cash flow positive may not be attractive to investors. David Rowe
Beyond buying physical gold and storing it at the Perth Mint, or holding a gold exchange traded fund (ETF), many investors have added gold stocks into their portfolio as a hedge against possible catastrophe.
One key mistake that many investors make when investing in gold stocks is believing they are buying into the same properties as the physical commodity.
It is true that in the short term, share price will be governed by the change in the price of the gold. However, over the long term, investors must realise that what they are actually investing in is a physical business: one that generates sales, pays expenses, makes profits, and ultimately is at risk from many of the same factors that can affect any business you invest in.
So, what should you look for when investing in a gold company? Or any mining business, for that matter? The complete answer is multifaceted, but here are basic principles to determine whether your gold stock is the quality business.
Fundamentals
Given the cyclical nature of the gold price, unless the company is sound fundamentally, particularly from a cash flow perspective, then it is at risk of not only failing but also needing to perform continuing capital raisings, which could dilute the interests of existing shareholders.
Gold explorers that are not yet producing or cash flow positive do not exhibit the safety properties investors may be seeking.
Resource size
Investors should know the amount of gold a company is sitting on, including the estimated mine life. Without it, you really don’t have a mining business.
As an added focus, look for reserve upgrades so that resources can be replenished, because once the commodity comes out of the ground, it’s gone. Therefore, reserve upgrades from existing sites or new projects are important for a gold miner’s long-term viability.
Good production profile
When it comes to commodity businesses, one outcome they can control is the amount they produce over a period. For all mining stocks, this is monitored quarterly, and investors can see the fruits of the company’s labour through announcements to the ASX.
Ideally, the company has an increasing production (ramp-up) profile, and can better absorb short-term commodity price volatility.
Cost management
In the same way the level of production can be controlled to a degree, so too the cost of extracting the resource. The all-in sustaining costs (AISC) of a mining business are also often declared every quarter. Investors can see whether the cost of actually getting the gold out of the ground is efficient and sustainable.
The higher the cost to extract the mineral, the more susceptible the business is to commodity price movements.
Currency moves
Gold is sold in US dollars. Therefore, for Australian producers who sell in US dollars but incur expenses in Australian dollars, a weak Aussie dollar is good for profitability. The other currency issue to consider is if the US dollar rises, historically the gold price falls and vice versa.
Many consider this correlation more important to the direction of gold prices than the fears that attract investors to gold in the first place.
The price of gold
Neither the miners nor investors can control the price of any commodity; they simply need to adapt. There are times when the gold price can fall to levels where many mines become unprofitable. Likewise, the price of gold can jump so much that even the lower-quality producers are making money.
An understanding of the key fundamental drivers of a gold miner is necessary to determine that it is indeed a quality business. This will ensure you identify a sound business to invest in because volatility in commodity prices is a fact of life, and investors need comfort that the underlying business can withstand shifts when they occur.
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