Gold Mining Companies: A Good Investment Opportunity?
Investing in gold mining stocks can be a good addition to your portfolio but as a growth investment which cannot be considered equivalent to hedging with gold bullion. The reason for this is that stocks in gold mining companies face many more challenges than simply the price of gold.
The valuation of gold mining shares is based on a number of factors including the company’s potential future revenue which is often impossible to predict. No one really knows how gold prices will evolve nor if the company will be successful in keeping their operational costs down or creating gold reserves.
One of the factors to affect gold mining shares is the relatively recent geographical shift of gold production. For example, up until 2006 the four major producing countries were South Africa, the United States, Canada and Australia but their share of the global production has slipped to approximately 36%. The reason being that large scale gold production has moved to other countries, whether due to discovery of new reserves or simply because of lower operational costs.
China has become the biggest global gold producer with the bulk of the industry being made up of small, private mines which produce little individually making them quite inefficient. However, there are large scale projects in development which also include foreign gold mining companies who are veterans in the industry. Thus the Chinese gold mining industry should see a boost in gold production as well as efficiency.
Another variable that affects the shares of gold mining companies is the expenditure on exploration. Annually over $7 billion are spent on gold exploration but one must remember that even though it sounds like a large budget versus previous years it does not take into account the effects of inflation nor the fact that exploration is generally more costly now. Everything associated with exploration from drilling to the cost of energy to labor have all become much more expensive. The problem is that all the easy gold has already been found and now gold mining companies are being forced to go to more remote and far flung locations to find new reserves which means that there is no supportive infrastructure and implicitly higher costs.
As an investor you should closely monitor how much any of the gold mining companies you wish to invest in spend on these projects and what the ROI is. The lower the exploration cost per ounce the higher the positive impact it will have on future earnings and thus the price of gold mining shares.
Rising operational costs are also a key factor in the value of gold mining shares. Even though gold mining companies are producing much more gold they are also paying a lot more to mine it than they did as little as a decade ago. Recent years has seen operational and exploration costs rise rapidly with production costs going up from around $170 per ounce in 2001 to over $400 in 2007, almost tripling in as little as six years. For this reason gold stocks have not performed as well as gold bullion even though gold mining companies have managed to maintain their margins, albeit with difficulty.
These are just a few of the factors that should influence your decision when deciding whether or not to invest in gold mining companies. It is best to treat it as an investment in any other corporate stock and not to lump it in with gold bullion, which plays a completely different role in a well structured investment portfolio.
