Written by Bron Suchecki, Vice President, Operations Monetary Metals LLC and Company Secretary, Gold Industry Group
The value of a gold miner is based on the gold price but provides the investor with the opportunity to achieve a return in excess of the rise in the price of gold.
Recent investor articles have focused on investment in gold, be it physical or other products liked to the gold price. Those looking for exposure to gold prices can also invest in the producers of the gold itself.
Gold miners offer leverage to the gold price given that they, broadly speaking, have a fixed cost to extract gold, while their revenue from selling that gold varies. For example, if the total cost of mining gold is $500 and the gold price is $1,000, then the miner earns $500 for every ounce produced. If the gold price rises to $1,500 (an increase of 50%), the miner now earns $1,000, which is a 100% increase, twice as much as the return one would have achieved just investing in bullion.
This is an overly simplistic example as any mine has a mix of fixed and variable costs and if the gold price rise is associated with general inflation or increase in costs of specific inputs into mining like labour, fuel or equipment, then the profit margin may not increase as much as expected.
The inherent leverage of a gold miner can also work in reverse, if the gold price declines, and the mining company cannot decrease costs at the same rate.
Larger established gold miners with operations that have a long life can pay dividends, compared to bullion which often has a negative yield as a result of storage costs. It should be remembered that a mine has a finite life and once the ore is exhausted the mine is worth very little. Ultimately the investment in each individual mine has to be recouped via the gold extracted and net profit returned to shareholders.
There is always the potential for a gold miner to make an unexpected discovery. While commonly associated with explorers (those who raise money to prospect and find gold), miners producing gold can also learn more about their ore body as they mine, resulting in upward revisions to the estimate gold reserves.
With return comes risk. Unlike physical gold, the business of mining introduces additional risks. Political risks can include changes in royalty and tax rates, or regulations, and these can be significant in less stable countries.
There are also technical risks which stem from imperfect information about the gold reserve being mined – mine plans are based on various sampling and measurement techniques to estimate the nature of the reserve. As mining progresses, these estimates may not pan out as expected, resulting in higher costs or lower mine life, for example.
On the other hand, an investor can mitigate these risks and increase their chances by applying themselves to education about gold mining and researching companies to identify those with superior prospects.
There are various subscription services available that either provide general information or specific tips and recommendations. If you like numbers and doing the work yourself, a service like GoldNerds will be ideal. Online forums can be useful to gauge investor sentiment or identify issues but one has to be careful about those just trying to promote a stock that they hold.